Can you exclude liability for dishonesty?

In Innovate Pharmaceuticals Ltd v University of Portsmouth Higher Education Corporation [2024] EWHC 35 (TCC), Roger Ter Haar KC (sitting as a Deputy High Court Judge) held that an exclusion clause was effective to exclude a party’s liability for dishonesty in performance of the contract by its employee – but also signalled that it would, in principle, be possible to exclude dishonesty by the party itself.

Background

The claimant in this case owns the patent for a formulation of liquid aspirin. It engaged with the defendant university to conduct laboratory research to explore the potential use of the drug in the treatment of brain tumours.

During the course of the research, the researchers published a paper in a prominent academic journal. The paper contained errors in the reporting of data, which led to criticism by peers and disciplinary proceedings by the university into the lead scientist’s research. The disciplinary panel found the researcher guilty of research misconduct, which ultimately precipitated the retraction of the research paper. The claimant argued that the research was “infected with errors” which the claimant said were, at least, careless, but which it also alleged were the product of the researcher dishonestly seeking to manipulate the data. The claimant sought damages from the university for loss, including the costs of repeating the research and diminution in the value of its patent.

A central issue at trial was whether claims based on allegations of the researcher’s dishonesty were excluded or limited by the liability clauses in the research agreement.

The liability clauses

The research agreement contained the following key liability clauses:

Clause 11.4

Except as provided in clause 11.5 the University is not liable to the Funders because of any representation (unless fraudulent), or any warranty (express or implied), condition or other term, or any duty at common law, non-observance or non-performance of this Agreement, for: any loss of profits, business, contracts, opportunity, goodwill, revenues, anticipated savings, expenses, costs or other similar loss; and/or any indirect, special or consequential damages or losses (whether for loss of profits or otherwise).

Clause 11.5

The liability of a Party to another howsoever arising (including negligence) in respect of or attributable to any breach, non-observance or non-performance of this Agreement or any error or omission (except in the case of death or personal injury or fraudulent misrepresentation) shall be limited to £1 million.

Construing exclusion and limitation clauses

The starting point when construing exclusion and limitation clauses is that they are commercial terms like any other and that they are subject to the normal rules of contractual interpretation. The judgment sets out a helpful reminder of key principles which courts apply when construing clauses that seek to exclude or limit liability. These include:

• Natural meaning – exclusion clauses mean what they say.
• Excluding is harder than limiting – the courts will take a more stringent approach to construing exclusions of liability than limitations of liability.
• Deliberate acts – liability for deliberate acts can be excluded – whether liability has been excluded is a matter of construction, not law. Wording which seeks to exclude “liability howsoever arising” is capable in principle of effecting an exclusion of liability, even for wilful default.
• Make or break distinction – a contracting party cannot exclude liability for its own fraud in inducing a party to enter into a contract; but can, in principle, exclude liability for fraud in performance of a valid contract.
• Fraud of party or agent – it is easier, effectively, to exclude liability for the fraud of a party’s agent or employee than it is to exclude liability for fraud of the contracting party itself.

The judge also referred to the principles of construction enunciated last year in the Pinewood case, which we covered in our previous article, including:

• Exclusion clauses are an integral part of pricing and risk allocation and are construed in accordance with ordinary methods of contractual interpretation.
• The more valuable the right, the clearer the wording must be to exclude it.
• There should be no strained construction of an exclusion clause which has a clear meaning.
• An exclusion clause won’t normally be interpreted so as to defeat the main object of the contract.

Did the clauses exclude liability for dishonesty?

Taking those principles of construction into account, the judge held the effect of clauses 11.4 and 11.5 was as follows:

• The exclusion of liability for loss of profits in clause 11.4 applied to all claims, except for fraudulent representation. However, the claimant had not effectively pleaded fraudulent representation – in particular, because the claimant did not plead reliance on any representation made by the research team.
• Liability for loss of profits caused by a breach of contract not involving a representation had been excluded – even if that breach was committed fraudulently.
• Even if the claimant’s claims had not been excluded, any claim other than for death, personal injury or fraudulent misrepresentation (liability for which cannot be excluded or limited) would be subject to the £1 million limit of liability in clause 11.5.

Consequently, even if the judge found the researcher had acted dishonestly, the defendant would not be able to recover more than £1 million.

Were the clauses reasonable?

The judge also found that these clauses were reasonable under the Unfair Contract Terms Act. He noted that the disjunction between the university’s fee for the research (£50,000) and the amount the claimant was now claiming in loss of profits (up to £100 million) highlighted the commercial reality (or, indeed, necessity) of such clauses as a way of the parties allocating risk.

For similar reasons, the judge found that a clause by which the parties agreed to “adhere to the general principles of honesty, fairness and integrity” did not help the claimant – because that too was subject to the exclusion / limitation provisions.

Outcome

Ultimately, the judge declined to find that the researcher had been dishonest; choosing instead to attribute the numerous mistakes to a high level of carelessness, explicable by personal and professional pressures.

The judge did, however, award the claimant damages for the defendant university’s failure to exercise reasonable care and skill which resulted in the publication, correction and retraction of the research paper. These damages (representing the costs to the claimant of repeating the research with a commercial laboratory) were capped at £1 million by the operation of the limitation clause.

Analysis – the “make or break” distinction

Although, as the judge noted, this is a highly unusual case decided on particular facts, it raises important points of principle about the drafting of exclusion and limitation clauses.

Firstly, this is further evidence we are seeing of the trend by the courts to enforce caps and exclusions of liability in business-to-business (B2B) contracts (see, for example, our earlier articles ‘Court upholds clause excluding loss of profit‘ and ‘Court upholds badly drafted liability cap‘). This is good news for drafters, as they can be reasonably confident that their words will stick.

But drafters will be surprised by the judge’s apparent suggestion that it is possible for parties to relatively easily cap or exclude liability for dishonesty or fraud in the performance of the contract. Many drafters will have assumed that where dishonesty or fraud is proven then the contract, including the exclusion clauses, unravels leading to unlimited liability. All drafters will (or should) make clear that there is no limitation of liability for fraudulent misrepresentation (as otherwise the entire agreement clause may fail), but may not also mention fraud – assuming if there is fraud, the limitation clause will not apply.

However, the judge in this case pointed out that the distinction between the impact of fraud in contract formation and performance has been recognised for some time, as expressed in the judgment in Frans Maas [2004] EWHC 1502: “Parties do not contemplate fraud in the making of a contract… But it is another thing altogether to say that parties do not contemplate the risk of deliberate wrongdoing at some point in the performance of a valid contract”.

The reasoning in this case on the ability of the clause to cap liability for dishonesty is obiter, as ultimately the judge decided the key witness had not been dishonest – but it will be a brave drafter to ignore the suggestion (or possibility) that a failure to expressly address this issue may lead to a cap on dishonest or fraudulent acts. Whether parties have excluded liability for fraud in a given case is a matter of construction of a particular contract, but it is important to be aware that the courts expect deliberate wrongdoing to be in the parties’ contemplation. Therefore, if you are drafting a contract and you don’t want the liability caps and exclusions to apply to dishonesty or fraud, then you should make that clear – it is, after all, difficult for the other party to resist in a negotiation.

For more information on any of the points raised here, please contact either David Lowe or Sean Adams.