Liability in Government Contracts

Summary

This note provides guidance to Contracting Authorities on the issues which need to be considered in deciding whether, and to what extent, contractor liability should be limited or excluded in Government contracts. It makes clear that limiting or excluding liability is a matter to be considered in each case on its merits reflecting the risks associated with the contract and value for money considerations.

Background

The most recent guidance on liability and insurance in Government contracts is included in the commentary on OGC's model conditions of contract for Services (condition G1). http://www.ogc.gov.uk/documents/Model_Services_Contract_050209.DOC This states that "Limitations of Liability should be considered on a case by case basis, and should reflect value for money. These issues must be considered at an early stage in the procurement process, and any exclusions or caps must be set before the issue of Invitations to Tender." 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.

Approach to liability

Decisions on liability remain the responsibility of the individual Contracting Authority, in the light of the specific circumstances, however, in the vast majority of cases liability will be limited to some extent. In considering liability, the Authority should take account of the following issues.

Death and Personal Injury

Liability should remain unlimited in areas where legislation (the Unfair Contract Terms Act 1977) proscribes limitation. These areas are liability for death and personal injury and for breach of the obligation to possess good title to goods that are sold or hired.

Direct Loss or Damage

There is no precise definition for direct loss or damage. The usual definition is that a direct loss is a loss which arises naturally and directly from the breach of contract or negligence. Losses will be treated, by the courts, as direct losses if they were reasonably foreseeable by the parties as being a likely consequence of a breach at the time that the contract was entered into.   For some contracts, eg in the IT area, it might be appropriate to have separate limits for different kinds of losses - damage to property (where the limit might relate to the property value), other pre-acceptance losses (including claims under IPR indemnities) and other post-acceptance losses.

Another issue is whether there should be a limit of liability relating to each "occurrence". However, this approach can introduce uncertainties into the limitation provision. Where there has been a catastrophic IT system development, for example, it is often difficult to pinpoint the exact cause of the problems and so to determine whether there should be a single or multiple application of the limitation provision. For that reason, it may be preferable to include a provision which specifies the total aggregate liability of the contractor. This means that there is a "pool" of damages available to the customer and once this pool has been exhausted no further damages will be available.

The limit or cap, itself, may be expressed as a sum of money or a percentage of the charges payable under the contract. However, particular care should be taken over using the contract price to determine the appropriate limit. Such an approach is attractive to the supplier because it will naturally prefer to avoid a situation in which the contract results in a net outflow of revenue. It is not, however, a good basis for limiting liability from the customer's point of view, since the contract price may be smaller than the loss that may arise if the supplier is in breach of contract. It is generally preferable for the customer to consider what limitation of liability it can comfortably accept without reference to the contract price. However, it may be advantageous thereafter to express that limitation of liability, independently arrived at, as a percentage of the contract price. This will provide for an automatic increase in the limit of liability where the later operation of a change control mechanism in the contract results in a price increase.  

The limit should not be so high that the commercial risk for the contractor becomes unacceptable. The aim should be to establish liability ceilings reflecting a combination of the best estimate by the Authority of the losses that might be suffered by the Authority (and any other relevant, associated bodies) in the event of a default by the contractor, the likelihood of those losses occurring and the value for money considerations in limiting liability. For estimating property losses, one approach is to make an assessment of costs associated with rebuilding, refurbishing and re-equipping premises in the event of destruction caused by contractor default, taking account of the potential risk. For non-property areas, estimating losses is often difficult. One approach is to assess the approximate costs of recovering from a " worst case" loss of service, based on the impact on the Authority and other users of the services.

Indirect and Consequential Loss, Loss of Profits etc

For indirect loss or damage, consequential loss or damage or loss of profits, business, revenue, goodwill or anticipated savings, there is a strong case for accepting a limitation or exclusion from liability, especially in contracts relating to more sophisticated procurement. However, it is important not to look at these kinds of losses in isolation. There may be a case for seeking to resist the total exclusion of claims for indirect or consequential loss etc where a general cap on liability has been conceded. Again, it is important to consider each case on its merits, in line with value for money considerations. There should be no exclusion from liability for any additional operational and administrative costs and expenses, or expenditure rendered unnecessary, resulting from the direct default of the contractor.

When to consider liability issues

Purchasers should consider these issues as early as possible in the procurement process - eg, when sourcing the market - and decide on any exclusion or cap before issuing the invitation to tender.

Model Clause

Above is the most recent guidance on liability and insurance associated with G1, which reflects the principles outlined above. We should stress that the clause, itself, is a "model". It is for the Contracting Authority to consider, with its legal advisers, how the clause needs to be adapted in the particular circumstances of the procurement.

Insurance - General

The levels of insurance cover should normally be a matter for the contractor, reflecting its estimate of the risks involved. However, the Authority may require, in the contract conditions, that the contractor should effect and maintain a policy or polices of insurance providing an adequate level of cover in respect of all risks which may be incurred by the contractor, arising out of the contractor's performance or purported performance of the contract.

Insurance - Employers' Liability Compulsory Insurance (ELCI)

It is a legal obligation on employers to insure against the costs of providing compensation for those employees who are injured or made ill at work through the fault of the employer. The sum insured must be at least £5 million. The client should ask to see a copy of the EL insurance policy and/or a copy of the certificate of insurance that the employer is required to display in the workplace under the Employers' Liability (Compulsory Insurance) Regulations (SI 1998 No. 2573).

Risk Management

It is important to look at contractor liability as part of a general consideration of risk management and risk sharing. At one extreme, it might be that pressure from potential contractors for low limits of liability indicate an unacceptably risky project which should be reconsidered or restructured. In any event, it is vital that, at all stages of a project, proper risk management systems are in place and that all approaches to risk sharing, other than limiting liability, are fully considered.

Parliamentary approval

Caps are not usually reportable, unless the contingent liability or contingent loss is significant (in £s) or of an unusual nature. Please see Annex 26.2 of Government Accounting.

Checklist

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).
  

Further advice

Any enquiries should be addressed to: OGC Service Desk, tel 0845 000 4999 (GTN 3040 4999), Email ServiceDesk@ogc.gsi.gov.uk