Parties to international commercial contracts (especially those that submit to arbitration) usually dedicate time and effort to tailor the rules of contractual liability applicable to each specific transaction. Side by side, parties’ obligations and the corresponding remedies for breach constitute the package of rights and duties that each party bargains for when entering into a contract. Likewise, remedies for breach usually inform the allocation of risks that each party accepts when concluding business dealings and, therefore, constitute a paramount element of negotiations. This is particularly true in the context of cross-border transactions, when different legal backgrounds may affect parties’ expectations under the agreement, in case one of them fails to perform accordingly.
When it comes to damages, contractual remedies for breach may range from sole remedy clauses, which establish damages as the primary form of redress, to exclusion of liability provisions, thereby wholly depriving the aggrieved party of remedies for breach (such as specific performance, reduction of price, substituted performance or termination). Somewhere in this spectrum, practitioners encounter the genus of damages limitation clauses, which are the subject of this chapter: contractual provisions that, while maintaining liability, limit the general availability of damages as a remedy for breach.
As one author puts it, damages limitation clauses are ‘an international phenomenon and an international problem’. Damages limitation clauses may raise issues of validity and efficacy, as the principle of party autonomy interplays with other relevant rules in contract law, such as the principle of full compensation or matters of public policy. Parties may also encounter restrictions as to what they might exclude (or limit) under these clauses. The answer to any of the above issues, however, depends on the rules applicable under each domestic legal system. Parties may, thus, benefit from choosing arbitration as their dispute resolution mechanism, as well as choice-of-law provisions to protect their legitimate expectations when negotiating these clauses.
This chapter aims to address the main issues that arise when dealing with exclusion or limitation clauses in the context of international arbitration. The first section is dedicated to describing the most prevalent forms that these clauses assume. The second section deals with matters of objective and subjective scope that these clauses may cover. The third section describes the main issues that international arbitrators have faced when dealing with damages limitation clauses. The last section discusses the interplay between damages limitation clauses and interim relief in international arbitration.
Damages limitation clauses: exclusion, limitation or pre-liquidation
It would be impossible to list all the forms of damages limitation clauses that can be found in commercial contracts; however, practice shows that these clauses may generally be categorised in three types.
The most extreme limitation clause is one that excludes the recourse to damages entirely, also known as an exclusion or exemption clause. To avoid issues of validity, parties must ensure that the obligee is not left without any remedy at all, so as not to affect the principle of consideration. In other words, if there are no consequences for a potential breach, this might render the contract as a mere offer of performance, subject to the will of one of the parties – and, thus, unenforceable.
A second type of clause is one in which the quantum of damages is limited (although not entirely excluded) by agreement of the parties. This type includes damages quantum limitation and heads of loss limitation clauses.
Damages quantum limitations are provisions that generally state the maximum (cap) of recoverable damages, although these clauses may also stipulate the minimum damages that may be pursued by the aggrieved party. This can be achieved by contracting a de minimis clause, whereby parties agree that individual damages may only be claimed if they are higher than a certain amount, meaning that damages of lesser value are not recoverable. Another form is by agreeing to basket clauses, whereby the aggrieved party may only seek redress after individual damages achieve a certain amount (whether individually or in aggregate). Parties may also stipulate deductible clauses, under which the aggrieved party may only seek damages if they are in excess of the stipulated amount, and only in the amount that exceeds the deductible.
Heads of loss limitation clauses are provisions that dictate which types of damages are excluded from compensation, such as loss of profits, diminution in value, consequential or indirect damages, etc. In many instances, the exclusion of certain heads of loss is contained in the limitation clause itself; however, it is not uncommon for parties to limit the recoverability of heads of loss by contracting a defined term (such as ‘loss’ or ‘damages’) that states which are the recoverable damages under the contract.
A third (and often overlooked) type of damages limitation clause is the pre-liquidated damages clause. Most civil law countries consider pre-liquidated damages clauses as a type of penalty clause, which are generally accepted under these systems. Pre-liquidated damages may fall within the scope of the full compensation principle, as an expression of party autonomy in determining the amount (or the formula to achieve such an amount) that is adequate to compensate damages. Pre-liquidated damages clauses usually serve to reduce transaction costs, by minimising disputes regarding the quantum of damages. These clauses usually function as a way to limit recourse to damages, because the losses actually incurred by the party may surpass, but must be limited to, the contracted amount (unless the parties have agreed that they may claim supplementary indemnification).
An issue particular to the arbitration setting arises when parties to an arbitration agreement limit the arbitrators’ remedial authority to exclude the power to grant certain types of damages. This kind of limitation departs from the ordinarily substantive nature of the limitation (subject, as such, to the law governing the contract and to the general principle of limited review), becoming an issue of jurisdiction. In this sense, parties must ensure that such a provision is authorised by the relevant lex arbitri. Also, a tribunal that oversteps this limitation may risk rendering an unenforceable award, on the grounds of abuse of authority.
Objective and subjective scope of damages limitation clauses
In drafting the objective scope of the damages limitation clause, parties should be mindful as to whether they might conflict with matters of public policy (ordre publique) or similarly broad principles (bonos mores, Treu und Glauben, unconscionability, etc.). This might be the case in which the limitation clause exempts the breaching party from damages arising out of fraud, gross negligence or wilful misconduct, or damages for personal injury and death, or for involvement in illicit activities (e.g., Foreign Corrupt Practices Act, UK Bribery Act or other corruption-related statutes). Also, a party may generally not rely on a limitation clause if it contradicts the main (or essential) obligation of a contract.
To assess the objective scope of a damages limitation clause, the arbitral tribunal should turn to the general rules of contractual interpretation and construction. Owing to the nature of the contractual provision in question, some advocate for a generally narrow (or strained) interpretation of limitation clauses, although recent case law departs from this canon. When they are contained in standard terms of contracts, the contra proferentem rule may be invoked to solve any ambiguity or obscurity found in the clause against the drafting party.
As to the subjective scope, parties are generally free to determine whether exclusion or limitation clauses shall apply to one or both of the contracting parties. In principle, there should be no inherent invalidity to a unilateral exclusion or limitation clause, which remains a bargaining point that ultimately sums up in the economic equation and the allocation of risks, considering the whole scheme of obligations under the contract.
Owing to the doctrine of privity of contract, only the contracting parties may generally rely on exclusion or limitation clauses; however, parties may also agree that exclusion or limitation clauses are extensible to third parties, such as beneficiaries to the contract or other persons tasked with contractual performance. In most civil law countries, this could be construed as a contract for the benefit of a third party. For other statutory references, in common law countries, see the United Kingdom’s Contracts (Rights of Third Parties) Act 1999, which expressly allows for a third party to avail itself of an exclusion or limitation of liability clause that is contracted on the third party’s behalf.
One such example is the Himalaya clause. Deriving its name from the SS Himalaya, the ship involved in the case of Adler v. Dickson, the Himalaya clause is a provision inserted in standard contracts from the maritime industry, which extends the limitation of liability from contracting parties to employees, agents or subcontractors of that party. The clause functions as to preclude the damaged party from seeking redress from third parties on the grounds of tort liability, whenever contractual liability is excluded or limited. The extent of this protection (e.g., which third parties may benefit, or which damages are excluded or limited) remains a matter of contractual construction.
Common disputes surrounding damages limitation clauses
Considering the general prevalence of damages limitation clauses in commercial contracts, it is not surprising to find that they have been subject to a number of international arbitration proceedings. The following paragraphs describe some of the common disputes that surround damages limitation clauses, as found in a number of public arbitral awards, and the conclusions reached by the tribunals in those arbitrations.
A common dispute arising out of damages limitation clauses is the validity of such a clause when a party breaches its obligations wilfully or with gross negligence. This issue was dealt with in Swedish Chamber of Commerce Case No. 156/2003, in which the United Nations Convention on Contracts for the International Sale of Goods was applicable. The arbitral tribunal held that the party who had wrongfully terminated the agreement – which was deemed a ‘conscious, willful decision, far exceeding the threshold for gross negligence’[16] – could not rely on a damages limitation clause. In the end, however, this discussion was rendered moot because the aggrieved party amended its request for relief to exclude the claim for damages that would be limited under the agreement.
A similar discussion was held in International Chamber of Commerce (ICC) Case No. 26404/PD. The parties discussed the applicability of a limitation of liability clause (cap) contained in two solar module supply agreements, in light of the claimant’s allegations that the respondent acted in bad faith when renegotiating the contractual price. The arbitral tribunal held that, under New York law, a limitation clause may not be relied on by a party acting in bad faith; however, considering New York law ‘pretty cold-hearted’, so as to provide for ‘stringent requirements’ for overriding contractual limitations, the tribunal held that tough negotiation tactics did not amount to bad faith, so as to exempt a party from the damages limitation clause.
ICC Case No. 16920 discussed the validity of an exemption of liability clause contained in the standard terms of a contract entered into between a shipping company and a shipyard. The dispute concerned mistakes in the design of a vessel by the respondents, which was constructed by the claimant. The case was subject to Dutch law. The sole arbitrator held that, even though the damages limitation clause was inserted in the general terms of contract, both companies were experienced, professional parties who participated in an industry where ‘standardization of contracts through general conditions with exemptions is a daily occurrence’ and, therefore, could not rely on protections from exemption clauses.
As mentioned above, the parties can also contract damages limitation in the form of exclusion of certain remedies from the general authority of the arbitral tribunal. This was held in ICC Case No. 21747 RD/MK/PDP. The arbitration agreement read that ‘the Arbitral Tribunal shall neither have nor exercise any power . . . to award special, indirect, consequential or punitive damages’. The tribunal thus held that ‘the Parties validly decided that this Tribunal would lack the power to hear claims for indirect or consequential damages’. This conclusion was relevant because the claimant sought compensation for these heads of loss on the grounds that the respondent had acted with gross negligence or wilful misconduct (culpa grave or dolo); however, since this was not an issue of substantive liability but rather a limitation on the tribunal’s jurisdictional authority, it did not circumvent the limitation on the grounds of negligence and wilful misconduct.
Damages limitation clauses and interim relief
It is well construed in international arbitration that one of the conditions for granting interim relief (whether precautionary or injunctive measures) is the threat of harm not adequately reparable by an award on damages; for example, this is provided in Article 17A(1)(a) of the Model Law on International Commercial Arbitration of the United Nations Commission on International Trade Law (UNCITRAL), which has served as a standard for many national laws on arbitration, and in Article 26(3)(a) of the 2021 UNCITRAL Arbitration Rules. This is also the opinion of certain scholars and case law.
What happens, then, if a party is faced with a threatened breach of contract, having contracted an exemption or limitation clause? How does this contractual condition interplay with the requisites for granting interim relief in international arbitration?
This issue was discussed by the Court of Appeal of England and Wales in AB v. CD, which referred to interim relief in connection with international arbitration proceedings. In that case, the claimant sought injunctive relief against the early termination of the licensing agreement entered into by the claimant and the respondent. The claimant argued that an award on damages would be ineffective because the licensing agreement excluded liability for loss of profits, and capped any recoverable damages by a prescribed formula.
The injunction was first denied by the High Court on the grounds that, in entering the licensing agreement, the claimant agreed to a ‘package of rights and obligations’ that included limited liability on the part of the respondent owing to the exclusion and limitation clause. Therefore, the claimant could be satisfied by an award for damages – even if damages were capped or excluded entirely by the contractual provision in question.
This judgment was later overruled by the Court of Appeal of England and Wales, which granted the injunction in favour of the claimant. The Court recognised that such clauses – irrespective of whether they are limitation or exclusion clauses – may lead to the inadequacy of a future award on damages when the applicant shows that the threatened breach would lead to losses that the applicant would be barred from recovering (in full or partially) because of the provision in question. However, the Court held that it still falls under the Court’s discretion to grant the injunction (or not), and ‘the fact that the restriction in question was agreed may, depending on the circumstances of the case, be a relevant consideration’.
As discussed above, damages limitation clauses usually restrict only that: the recourse to damages. Unless such a clause states otherwise, it does not exempt the breaching party from liability, and, as such, does not limit the recourse to other remedies for breach of contract. A future award on damages may be an inadequate remedy for the threat of imminent harm, thus allowing for interim relief. Tribunals should look into the other contractual provisions, as well as the allocation of risks underlying the contract, to ascertain whether this was something that the parties bargained for when contracting the damages limitation clause.
Conclusion
Damages limitation clauses play an important role in risk allocation, as well as managing parties’ expectations under commercial contracts; however, to achieve this goal, parties should ensure that the relevant domestic law applicable to the contract protects these expectations, in terms of the objective and subjective scope of application, in light of any mandatory rules that may supersede the parties’ agreement on this point. If the limitation is contained in the arbitration agreement, thus limiting the arbitrators’ remedial authority, the same considerations apply, provided the parties look into the relevant lex arbitri.