[Boring and technical] Why UK government, and any, suppliers should not accept limitation of liability, and why procurement people should never ask for it…
Limitation of liability
Most professional indemnity insurance will not cover unlimited liability or, where it does so, will be truly prohibitively expensive.
RedQuadrant pays £8,000 per year, and our liability limits are:
- public liability: £10m total (£5m + £5m excess)
- employer’s liability: £10m
- professional indemnity: £5m
As I learned at PwC and Capita, there are good reasons why it is not commercially acceptable to accept contracts with unlimited liability, or liability over the single claim insurance limit; firstly, to do so would invalidate insurance contracts.
Typically, we propose a limit of liability at the value of the contracts terms (on an annualised basis).
Our standard terms of business include:
1.4. Subject to Clauses 8.2 and 8.3, the total aggregate liability of RedQuadrant arising out of, or in connection with, this Contract whether in tort (including negligence), breach of contract or any cause whatsoever shall in no event exceed 100% of the aggregate amount of the charges paid by the Client under the relevant Engagement Letter or Proposal in the preceding twelve (12) months or £1m whichever is the smaller.
At other times, we have been willing to agree a liability limitation of three to six times contract value. We are not able to accept liability in the areas covered by our insurance which are above the single claim limits set out above — or if required to, we would seek to negotiate contract terms which take account of the additional insurance cost incurred. In twelve years as a professional consultant in businesses large and small, I have never had to agree a higher limit than those for which we are currently insured. I have, however, been asked to do so many time!
In terms of other major frameworks, for example, the ESPO pan-government framework contract includes this limitation:
Subject to the provisions of Clause 22 of the Order Terms:
(7.1) the aggregate liability under the Contract of either Party for all Defaults shall in no event exceed the greater of 125 per cent of the Contract Charges payable by the Customer to the Consultant.
The Cabinet Office Commissioning Academy framework has a similar liability level:
29.2.1 the aggregate liability of the Supplier in respect of all defaults, claims, losses or damages howsoever caused, whether arising from breach of the Agreement, the supply or failure to supply of the Services, misrepresentation (whether tortuous or statutory), tort (including negligence), breach of statutory duty or otherwise shall in no event exceed a sum equal to 125% of the Charges paid or payable to the Supplier; and
A key principle of contracting is mutuality of obligation, and therefore limits of liability should typically operate in an equitable way in both directions. There are of course corporate conduct actions which cannot be covered by insurance which therefore are not subject to limitation of liability at all, but these are easily and normally excluded in contracts.
It is also important to note that the imposition of an uninsurable risk on the consultant — since we have very limited resources — creates no appreciable benefit for the client. Ultimately, it is counterproductive to ask for a potentially infinite liability for a small piece of consultancy work.
Examples from elsewhere
- gov.uk (OGC guidance). 3
- House of Commons, Public Administration Select Committee. Government and IT — “a recipe for rip-offs”: time for a new approach. Twelfth Report of Session 2010–12. 4
- Professional indemnity concern for consultants: Steve Timbs, 24 February, 2015. 4
- Policies and Incentives for Consultants in Various Countries, published 2010. 5
- Clients and consultants go to war over project liability, 2005 issue 21. 5
- Liability Briefing October 2008. 5
- Let’s get rid of the unlimited liability clause, John Bowen, 8 April 2013. 5
- Managing the liability risk of appointing consultants, James Pargeter. 6
- Unlimited liability demands put consultants at risk 15 March, 2007 | By Andrew Mylius. 8
- Consultancy — good practice guide. 8
- ContractorUK discussion forum.. 8
- Contract Good Practice, an ACE guide. 8
- Unlimited Liability, October 21, 2010. 9
- Negotiating Liability Clauses — Why is it Always So Difficult? Alistair Maughan 10/12/2006. 9
gov.uk (OGC guidance)
“There has been a tendency in previous years to insist on unlimited liability in many circumstances, regardless of the facts of the case. This is likely, in many cases, to have had an adverse impact on competition and value for money where, for example, suppliers have refused to take part or where tender prices have been increased to compensate for the insurance costs of meeting unlimited liability”
The main messages from this guidance are:
· decisions on limiting contractor liability should be taken by Contracting Authorities on a case-by-case basis, reflecting value for money considerations;
· liability should remain unlimited for death and personal injury;
· in most cases, value for money considerations will mean that limits will be appropriate;
· limits or caps should, preferably, be expressed as a sum of money rather than as a percentage of the contract value, reflecting a combination of the best estimate by the Contracting Authority of the losses that might be suffered by the Authority, the likelihood of those losses occurring and the value for money considerations in limiting liability;
· where appropriate, consideration may be given to excluding indirect and consequential losses altogether. However, there may be a case for resisting such exclusions where a general cap on liability has been agreed;
· liability issues should be addressed as soon as possible in the procurement process; and
· insurance cover is a matter for the contractor, although a requirement on the contractor to maintain a policy of insurance at an appropriate level might be considered necessary in some cases.
The contractor must hold insurance of at least £5 million for the purposes of Employers’
Liability Compulsory Insurance (ELCI)
Contracting Authorities should ask to see the evidence (the policy and/or the certificate)
of Employers’ Liability Compulsory Insurance (ELCI).
House of Commons, Public Administration Select Committee. Government and IT — “a recipe for rip-offs”: time for a new approach. Twelfth Report of Session 2010–12
“Other SME unfriendly practices
“58. We also heard that the Government’s standard contracts discriminate against SMEs, since they include complex obligations regarding unlimited liability… It was suggested that standard government contracts should be designed for SMEs by default, with SIs left to negotiate exceptional arrangements for more complex work.”
Professional indemnity concern for consultants: Steve Timbs, 24 February, 2015
“Will the UK market ever return to fairer practices? This feels some way off at the moment.
“It is important that there is a clear match between liability levels and PI provisions contained within any appointment or reliance letter”
Policies and Incentives for Consultants in Various Countries, published 2010
“[Unlimited liability] is of particular concern to consultants because strict liability is not generally available under professional indemnity insurance policies… The argument that the imposition of uninsurable risks on consultants, who have very limited assets, will not benefit the client, does not seem to convince the clients of the ineffectiveness of this move”.
Clients and consultants go to war over project liability, 2005 issue 21
Liability Briefing October 2008
“Consultants protect themselves against the financial consequences of being sued with professional indemnity (PI) insurance… Although liability can not be excluded or restricted in relation to damages for death or personal injury, parties to a contract can agree to limit any other liability that they may incur to each other… One method — now accepted by many clients — is to agree a figure (a financial cap), beyond which the consultant will not be liable.
“For all practical purposes there is no such thing as unlimited liability. Recovery from a limited company or limited liability partnership is limited to its insurance cover and the assets of the company or LLP; even in the case of an individual or partnership, recovery is in practice similarly limited — no individual or partner has unlimited funds. A cap therefore gives clients as well as consultants a degree of certainty they would not otherwise have.”
Let’s get rid of the unlimited liability clause, John Bowen, 8 April 2013
“Over the last 10 years or so we have seen, at least in the UK, a far more litigious approach to business and the impact on contract terms has taken on extreme tendencies.
“One of the most insidious of these is the unlimited liability, or indemnity, clause whereby the client expects the supplier to entertain unlimited claims upon them. These are a patent nonsense and I could write a small book on the subject, but for the purpose of this column the ability of the supplier to pay is one factor, backed by the level of insurance cover that they can obtain.
“What is unlimited? It could mean £100 or £50bn or anything between or beyond so where does that lead to? For a start you have the problem of having several such contracts whereby you are carrying the risk, or trying to insure the risk, of more money than there is in the world, at least in theory.
“Well the reality is that most contracts there days are not worth the paper that they are written on and any dispute would be settled through litigation. The liability would be limited to what the court decided. In other words, managers elect to take a risk in the knowledge that it is not likely to occur and that if it does, their lawyers will be able to argue the case well enough to reduce the consequences.
“We talk about reducing costs as clients, so why are we adding the costs of these contract terms into the supply chain? Let’s be realistic and start to remove the unlimited liability clause from our contracts: The only people who benefit from them are lawyers.”
Managing the liability risk of appointing consultants, James Pargeter
“It’s in no-one’s interest, whether client or consultant, to sign up to appointments on projects without an appropriate and defined aggregate cap on liability.
“Rather than clients and consultants assessing a project or assignment in advance and agreeing a worst-case scenario which then defines an appropriate risk level, the default position in the sector continues to be one of uncapped liability, regardless of the nature or magnitude of the project.
“There appears to be a degree of misunderstanding about the differences between a defined level of Professional Indemnity Insurance (PII), and a limit on consultants’ liability.
“Not only that, but there appears to be a degree of misunderstanding about the differences between a defined level of Professional Indemnity Insurance, and a limit on consultants’ liability — or at least an unwillingness to amend the status quo.
“Although larger projects imply greater levels of risk, it does not follow that unlimited liability is appropriate for any project, whether large or small.
“Current sector perceptions
“When I find myself discussing this issue with a client’s development or procurement teams, the usual response is one of the following:
● ‘that’s what has been drafted by our solicitors — we can’t change it’
● ‘every other organisation has signed up, why can’t you?’
● ‘but we have defined the PII level required’ (which is not the same as ultimate liability)
● ‘we can agree a cap, but only on an ‘each & every’ claim basis’ (ie. effectively not capped at all)
“When I have discussed the issue with solicitors, their typical response is either ‘we haven’t received any contrary instructions from the client’ or ‘we need to protect our client’s best interests’.
“Let me illustrate the problem by way of a couple of examples:
“Example 1: small/modest-sized project — construction value £2m
“The RP client needs to appoint suitable consultants to the project team. Whether via a framework or not, the requirement defined in the draft appointment is for a minimum level of PII of £2m.
“For either large organisations or SMEs, most practices will hold that level of PII and, for a project of this nature, that could be seen as reflective the worst case scenario (ie. the project turns out to be a total disaster and blame is fully attributable to just one consultant within the project team).
“Even that scenario seems a little far-fetched but, even if we agree that it represents a realistic risk that requires mitigation, what is preventing the client accepting that the aggregate cap on each consultant’s liability can be defined as £2m?
“Example 2: large/complex project — construction value £20m or greater
“Again, the RP client needs to appoint suitable consultants to the project team.
“In this case, this will almost certainly be via an OJEU-compliant framework and, due to the type of project, the minimum PII requirement defined in the draft appointment has now been sensibly raised to £5m.
“Some smaller practices may not hold that level of PII and will therefore not be eligible for consideration.
“Other practices may hold that level of PII and will be prepared to sign such an appointment for commercial reasons, probably the opportunity to be involved in a project of this nature.
“Large consultant organisations, of the type that might be expected to be more appropriate for this type of project, are now increasingly excluding themselves from consideration on the basis that there is no defined cap on their potential liability, even where the risk level is relatively normal or even minimal.
“Those consultants who could bear a large loss will not sign up to such appointments, and those who do sign up could not actually bear such a loss. That is surely not in the client’s interests.
“I suggest that it is in no organisation’s interest, whether client or consultant, to sign up to appointments on projects of any size without such an appropriate and defined aggregate cap on liability.
“This approach will protect all parties and make successful delivery more likely into the future.”
Unlimited liability demands put consultants at risk 15 March, 2007 | By Andrew Mylius
“CONSULTANTS RISK being put out of business unless clients stop passing on unlimited liability in contracts, insurers warned this week.
“The high cost of professional indemnity (PI) insurance, they said, meant that consultants often did not earn sufficient fees to pay for sufficient cover.”
Consultancy — good practice guide
“Things you shouldn’t do include:
- agreeing to unlimited collateral warranties*
- signing up to unlimited liability”
ContractorUK discussion forum
No company should be agreeing an indemnity clause like that — it means your liability is UNCAPPED and you CANNOT get insurance for an uncapped liability. What they are asking for is unreasonable so push back and tell them that the best you can do is cap the liability to the limit on your insurance.
Tell them that they would provide an uncapped indemnity back….
Contract Good Practice, an ACE guide
“Every PII policy has a limit of indemnity. This is the maximum amount that the insurers will pay… The insurance market does not provide policies with an unlimited amount of PII cover. Whilst the market is comparatively ‘soft’ at the moment, the insurance market is cyclical and prices will undoubtedly increase again, with costs passed on to clients. One way that consultants can control the cost of PII premium costs is to seek a reasonable limitation of liability. The main asset of most consultants is intellectual as opposed to financial. The effect of this is that consultants can only fund their professional liabilities to the extent that they are insured.
“The concept of unlimited liability is fundamentally flawed. It is for this reason that consultants are unable to accept unlimited liability.
“We recommend that the consultant’s liability be limited to an amount which is agreeable to both parties, thus providing relative certainty for both parties. A financial cap is not the same as the limit of indemnity under a consultant’s PII policy. A consultant’s PII policy will have an ultimate limit on the amount that the insurer will pay. The scope of the cap will depend on various factors such as the likely nature and extent of the risks of the project (having regard to size, complexity, etc), an assessment of the damages that could be payable in the event of negligence and any previous dealings between the parties. The duration of the consultant’s liability should be clearly defined.“
Unlimited Liability, October 21, 2010
“The problem with unlimited liability is that (at least in some jurisdictions) it may be precisely that — i.e. unlimited. Unlimited liability is not in general insurable, so the value of such a term of course depends on the size and assets of the company bearing the risk of loss. But more broadly, any unthinking attempt to apply such clauses is intellectually lazy and should be avoided.
“How often are such clauses exercized? How frequently are they upheld? What is the economic value realized from them, versus the economic costs of including them (extended negotiation time, strained relationships, more cautious suppliers, less delivery of innovation, higher prices to cover the risk etc.)? Is the party agreeing to the term capable of fulfilling it? When an organization or its lawyers prescribe these onerous terms, to what extent do they consider these wider questions? Far too often, the answer appears to be ‘not enough’; so long as there is compliance, the quality of that compliance doesn’t really matter.
“IACCM professionals — buy side and sell side — should not accept such positions. We must insist that the terms we are negotiating make sense, are proportional and that they drive the successful results that caused us to form a contract in the first place.
Negotiating Liability Clauses — Why is it Always So Difficult? Alistair Maughan 10/12/2006
Although we all recognise that the heart and soul of an outsourcing transaction lies in issues of service, price and governance, it has always been the case that an inordinate amount of time in outsourcing negotiations gets taken up with legal issues. And of those legal issues, the one that tends to absorb the most time is the Liability Clause. By this, I mean the clause that stipulates who pays what if something goes wrong, what types of loss can and can’t be recovered and, most controversially, the maximum liability of either party in the event that something goes wrong which causes a loss.
Too often, I seem to find myself faced with 2 positions that I find equally untenable — the Customer who expects a Service Provider to pick up uncapped liability; and the Service Provider who refuses to accept responsibility for seemingly obvious potential losses — financial loss, for example, in a financial services sector BPO where the very nature of the services provided inherently involves exactly that type of risk.
There ought to be a few clear points of agreement around the topic of Liability Clauses. For example:
In strict numerical terms, it is now universally accepted (I hope) that across-the-board unlimited liability clauses are not realistic. This took some time to permeate to certain sectors — especially the public sector. But it is now common practice that the exposure of a defaulting party under contract ought to be financially limited in some way. Having said that, there are still certain areas where uncapped (i.e., unlimited) liability is routinely negotiated — for example in relation to IPR infringement (or other) indemnities, or in relation to liability based upon fraud. The other area that often is discussed in this context is unlimited liability for what lawyers call “wilful abandonment” — the argument here being that it should not be cheaper for a Service Provider to “walk away” from a poorly performing contract than to continue to perform it — and therefore if a Service Provider does seek simply to abandon a contract then its liability ought to be uncapped.
A typical starting point for negotiations on financial limits is often an annual cap of 100% of annual contract value — and the parties then negotiate up or down from there. Having said that, if one thinks about it there is simply no logical connection between the size of a contract and the scale of potential loss: on some large contracts, the potential exposure to loss can be minimal; whereas, conversely, even on contracts that have a relatively small value, if the services are of the right kind, then the scale of loss can be enormous. But “proportion of contract value” has come to be recognised as a handy yard-stick for assessing and determining caps on liability and most Service Providers cling to that yard-stick as if to a life-belt.
Generally, it will suit an outsourcing Customer to have a single cap on liability: whereas it will tend to suit a Service Provider to have as many as possible (and as small as possible) sub-divided “pots” of liability, with each pot being set against a particular type or cause of loss. The reason for this is simple; the more a liability exposure is sub-divided, the more likely it is that significant losses are likely to be cut-off by the pre-agreed cap on liability.