Walking Away From Unprofitable Contracts – Can You Rely On Limitation/Exclusion clauses?

Unprecedented price spikes across commodities this year have turned international trade on its head as sellers try to walk away from contracts by invoking limitation or exclusion of liability clauses to excuse or limit the consequences of their non-performance to a trifling fraction of today’s market price. These clauses, broadly described as exception clauses, have thus come into sharp focus – in particular, as to whether traders can rely on them opportunistically to renege on contracts. Exception clauses are not uncommon for spot or term contracts. Typically, they exclude consequential losses, or cap loss exposure from a breach to a small percentage of the contract price. Interpreting exception clauses however is not straightforward, and their application can be particularly tricky to deliberate fundamental breaches of contract such as jettisoning a less profitable contract for a more lucrative one in a rising market.

Interpreting the exception clause: purpose of contract and the circumstances of its conclusion

The purpose of the contract and the circumstances in which it was made are important in interpreting exception clauses, such that an exception clause must be interpreted in the context of other provisions of the contract, the factual background in which the contract was concluded, and the commercial purpose of the transaction.

To illustrate, the Singapore Court of Appeal in Singapore Telecommunications Ltd v Starhub Cable Vision Ltd [2006] 2 SLR(R) 195 considered the purpose and circumstances of the conclusion of the contract in deciding against the applicability of the exclusion clause in question. Here, Singtel had contracted to lease its facilities to Starhub for the purposes of cable TV rollout in Singapore. The contract only covered high rise residential properties and excluded commercial and landed properties. Singtel later discovered that Starhub had developed its own infrastructure and was tapping into Singtel’s signals from the permitted properties to the excluded properties. Singtel sued Starhub for breach of the agreement claiming loss of revenue which it otherwise would have earned under a prospective lease. In response, Starhub invoked an exclusion clause in the contract which provided that neither party would be liable for “any indirect, incidental, consequential, or special damages (including, without limitation, damages for harm to business, lost revenues or lost profits) regardless of the form of action or whether such Party had reason to know of such damages”. The Singapore Court of Appeal found that the exclusion clause did not apply, reasoning that it had to be read in its proper context and its application restricted to the circumstances that parties had in mind when concluding the contract. At the time, tapping was not envisaged, and the exclusion clause was limited to damages that arose while parties were doing what was contemplated under the contract, i.e., using the facilities for cable TV roll-out to permitted properties.

Does the exception clause apply to a fundamental or deliberate breach of contract?

English authorities clarify that exception clauses will never normally be interpreted as extending to a situation which would defeat the main object of the contract or create commercial absurdity despite the literal language used. Thus, a fundamental breach of contract which undermines its main object, is a relatively weighty factor against construing an exception clause as applying to the fundamental breach. If the breach is deliberate, English law further suggests that there would be a presumption against the application of the exception clause to it; and the more radical the breach, the clearer must be the language of the clause to cover it.

These principles are illustrated by the decision of Internet Broadcasting Corporation and another v MAR LLC [2009] 2 Lloyd’s Reports 295, which concerned a contract under which the claimants were to, among other things, construct and operate a TV channel for the defendant. The defendant issued a notice purporting to terminate the contract, which it was common ground, was a repudiatory breach. The question here was whether the defendant could rely on an exclusion clause which excluded either party’s liability for, among other things, any loss of profit, anticipated profit, revenues, anticipated savings, goodwill or business opportunity or any indirect or consequential loss or damage. The court found against the defendant, as the exclusion clause was not found to contain any clear statement that deliberate wrongdoing was intended to be covered and, in any case, a literal meaning of the clause would have defeated the main object of the contract.

An exemption clause was found inapplicable for similar reasons in Kudos Catering (UK) v Manchester Central Convention Complex Ltd [2013] 2 Lloyd’s Law Reports 270, where the defendant had appointed the claimant as the exclusive supplier of catering services at two venues for 5 years but then prematurely purported to terminate the agreement. A claim for loss of profits for the remaining 20 months of the agreement was brought against the defendant, who contested liability under an exclusion clause which provided that the defendant shall have “no liability whatsoever in contract, tort … or otherwise for any loss of goodwill, business, revenue or profits, anticipated savings or wasted expenditure (whether reasonably foreseeable or not) or indirect or consequential loss” suffered by the plaintiff “in relation to” the contract. The court found the exclusion clause to be inapplicable, reasoning that the defendant’s construction of the clause would reduce the contract to a mere declaration of intent. The court also considered that if there are two possible constructions of the clause, it was entitled to prefer the construction consistent with common sense. The defendant’s construction was not consistent with common sense as it defied the presumption that neither party intends to abandon its remedies for breach of contract. Further, construing the agreement as a whole, in line with common sense, the court read the phrase “in relation to” the contract as referring to “in relation to the performance” of the contract; the exclusion thus related to defective performance, not a refusal, disability or inability to perform.

Exception clauses may also be inapplicable for the added reason that they do not cover a failure to perform contractual obligations (as opposed to their defective performance). Thus, in “CAP PALOS” v George Adler (1921) 8 Ll. L Rep 309, Atkin LJ postulated that a tug owner who cast off the tow in a storm for the purpose of engaging in a more profitable salvage operation would not be protected by an exclusion clause in a towage contract. This case concerned the breach of a towage contract by a tug owner. The vessel became a constructive total loss after its tugs had parted, and the court found that if assistance had been sent to the vessel (as required under the towage contract), she could have been saved from becoming a constructive total loss. In the circumstances, the court considered that the tug owner could not rely on the exceptions clause as the clause only covered a default during the actual performance of duties under the contract, not to an unjustified handing over of these obligations to someone else.

While the nature of a fundamental breach may weigh against the application of an exception clause, it is not determinative – there are cases involving widely and clearly worded exception clauses which were found to cover fundamental breaches (e.g., Mitsubishi Corporation v Eastwind Transport Limited and others [2005] Lloyd’s Law Reports 383 and Ailsa Craig Fishing v Malvern Fishing [1983] 1 WLR 964). As a rule of thumb, the more fundamental the breach sought to be excluded, the clearer the words that need to be used to cover it. As a matter of drafting, it is critical for parties to consider whether their exception clauses are intended to apply to deliberate or fundamental breaches of contracts, and circumscribe the clauses accordingly. Very widely drafted exception clauses might turn a seemingly binding contract into a mere declaration of intent, with disastrous consequences in a rising market.

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