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Japan – Limiting Liability In Construction Contracts.

31 July, 2012

 

Legal News & Analysis – Asia Pacific – Japan – Construction & Real Estate

 

Limitation of liability clauses are an effective tool to transfer, avoid or manage risk under engineering and construction contracts.  In this newsletter we outline some of issues which should be considered when negotiating limitation of liability clauses, with specific reference to clauses in the Silver Book (FIDIC Conditions of Contract for EPC Turnkey Projects) by way of illustration.
 
1. Liquidated damages
 
The basic principles of liquidated damages for delay were explored in our January 2010 Newsletter, 'Basic Principles of Liquidated Damages' [click here], including whether they will be an exhaustive remedy for a failure to complete the works by a contractual completion date.  The Silver Book removes any doubt which may subsist as to whether delay damages are an exclusive remedy. The Silver Book provides that delay damages are the only monies due in the event of late completion other than in the event of termination for contractor breach under SubClause 15.2 (Sub-Clause 8.7). Further, contractors routinely seek to cap their liability for liquidated damages (see below).  
 
There may also be circumstances in which delay liquidated damages may not be appropriate, such as projects where the procurement strategy includes multicontracting or where the contractor must achieve a milestone by a key date and it is very difficult to pre-estimate the resulting losses with any degree of certainty.  In the latter case, clear words will need to be used so as to ensure that the liquidated damages provision does not apply in those instances.
 
The Silver Book anticipates that a regime may be included in the Contract for the payment of performance damages in the event that the Tests on Completion are not passed.  Sub-Clause 9.4 provides that the Employer may in such event stillissue the Taking-Over Certificate but the Contract Price will then be reduced to reflect the reduced value of the Works to the Employer which, if not stated or capable of calculation by reference to the Contract, will either be agreed or determined as an Employer's Claim.  Again, this is intended to be an exhaustive remedy for performance failure as the reduction in the Contract Price is "in full 
satisfaction of this failure…"
 
2. Caps on liability
 
English common law limits the damages recoverable in the event of a breach of contract to damages which "may fairly and reasonably be considered either arising naturally, i.e. according to the usual course of things from such breach of contract itself [first limb], or such as may be supposed to have been in the contemplation of both parties at the time they made the contract, as the probable result of the breach of it [second limb]." (Hadley v Baxendale (1854) 9 Ex 341) 
However, when this principle is applied to major projects in the modern era, such as power and other revenue generating projects, it can lead to results which contractors are not prepared to underwrite as the recoverable losses could well be extensive.Consequently, caps on liability are common in international projects.  The first thing to consider is the basis upon which the cap applies (e.g. in the aggregate or on some other basis such as a cap per claim arising out of the same originating cause, which may reflect insurance cover available to the contractor) and what exclusions should apply. By way of example, Clause 17.6 of the Silver Book provides for a default aggregate cap of 100% of the Contract Price.  It also provides for exclusions from this cap, including the prices for utilities available at the Site consumed by the Contractor, damage to free issue materials and equipment provided by the Employer, third party indemnities (because they are insured losses), intellectual property rights and wilful or deliberate default.  This means that anything which is not expressly excluded from the cap is included.  Therefore, a breach of the Contractor's obligation to comply with the applicable law (Sub-Clause 1.13), design error (Sub-Clause 5.8), testing (Sub-Clause 7.4), failure to pass tests on completion (Sub-Clause 9.4) delay damages (Sub-Clause 8.7), and any payments after termination to the Employer (Sub-Clause 15.4) would all, therefore, fall within the cap.
 
Liability caps must always be considered within the context of the contract itself. Contractors should not assume that the inclusion of a cap on liability in the construction contract will exclude all liability above the level of the cap in respect of the whole project.  The contractor will still be liable for claims by its subcontractors and suppliers that cannot be passed up the chain to the employers and claims in tort by third parties.
 
3. Consequential losses
 
Clause 17.6 of the Silver Book also includes a mutual exclusion of liability for what is commonly referred to as "indirect or consequential loss or damage" i.e. the types of loss described in the second limb of Hadley v Baxendale (see above) being losses which do not directly and naturally result from the breach in the ordinary course of events.  The drafting of Clause 17.6, however, covers a common misconception of the rule in Hadley v Baxendale discussed in our September 2011 Newsletter 'Direct or Indirect Loss' [click here].  It is commonly 
thought that a claim for loss of profit falls exclusively within the second limb as it does not directly and naturally result from the breach in the ordinary course of events and, therefore, an attempt to exclude "consequential and indirect losses" is sufficient to bar any claim for loss of profit.  However, under English law, certain types of lost profit are capable of falling within the first limb and would still be recoverable.  Again, careful consideration needs to be given to the application of 
the exclusion.  For example, any loss of profit element included in a claim against the contractor by a third party for an employer's breach of its intellectual property rights may not be recoverable from the employer by reason of such an exclusion of consequential losses.
 
4. Limitation Periods
 
The Silver Book provides at Sub-Clause 11.10 that each Party remains liable for the performance of an obligation unperformed at the date the Performance Certificate is issued (i.e. the Works have been accepted).  Under English law, claims must be brought within a set period of time after the cause of action arises otherwise they are time-barred.  The effect of this is to bar the remedy but not the right to bring proceedings so if a limitation period has expired, the defendant will need to specifically plead limitation. If applicable (and pleaded), the expiry of a 
limitation period is a cast-iron defence to a claim. 
 
In the absence of very clear words to the contrary (Oxford Architects Partnership v Cheltenham Ladies College [2006] EWHC 3156, TCC), the law requires that claims in contract are brought within 6 years where the claim is founded on a simple contract (S5 Limitation Act 1980) and 12 years in the case of a deed (S8 Limitation Act 1980) from the date the cause of action accrued.  Sub-Clause 11.10 does not change this.
 
In cases where latent defects are likely to manifest themselves within a short period after take-over, the employer may be more willing to accept a shorter limitation period than that imposed by law although an employer will want to give careful consideration to the possibility of when third party claims, in respect of matters which are the responsibility of the contractor under the contract, could be brought against the employer.
 
However, it is common on most construction contracts to provide an earlier cut-off date for claims, for example by reference to the final payment process (subject to any claims arising during the defects liability period) or by reference to the expiry of the defects liability period.  The approach taken will vary by sector and by project.
 
5. Exclusive Remedies
 
Where English law applies to the contract, common law remedies such as claims founded in tort may apply in addition to a claim in contract.  This can be advantageous as the limitation period within which claims can be brought in tort isdifferent, as time runs from when damage suffered (S2 Limitation Act 1980) , and, in the case of latent damage, the period can extend up to 15 years from the date the negligent act occurred (S14A Limitation Act 1980). The Silver Book does not seek to exclude such remedies and for this reason contractors often ask for the Silver Book to be amended to provide that it sets out each party's exclusive remedies. Note that clear words must be used in order to successfully exclude liability for negligence under English law. 
 
6. Representations/inducements
 
It is usually in the best interests of each party to ensure that the conditions of contract it is negotiating are the sole reference point to establish the rights and obligations of the parties. Thus construction contracts frequently include "entire agreement clauses" which seek to exclude collateral contracts such as the contractor's accepted tender or early letters of intent.  However, such clauses will not exclude liability for misrepresentation unless clear words are used.  As Jacob J said: "…if a clause is to have the effect of excluding or reducing remedies for 
damaging untrue statements then the party seeking the protection cannot be mealy-mouthed in his clause.  He must bring it home that he is limiting his liability for false words he may have told." (Deepak Fertilisers and Petrochemical Corporation v Davy McKee (London) Ltd and ICI Chemicals & Polymers Ltd [1999] 1 Lloyds Rep 387)  Therefore, if a party is relying upon a precontractual representation as an inducement to entering into a construction contract, and the contract in question purports to exclude liability for precontractual representations, it should ensure the entire agreement clause clearly states that liability for misrepresentations is excluded. For a more detailed discussion on this issue, see our June 2011 newsletter 'Entire Agreement Clauses, Implied Terms and Misrepresentations' [click here]
 
7. Local law requirements
 
Whether exclusions or limitations on liability are enforceable will depend upon the applicable law.  Under some systems of law there may be mandatory requirements which need to be observed. Thus, under English law a party cannot exclude liability for death, personal injury, or fraud.
 
Conclusion
 
Whilst the Silver Book includes provisions which limit or exclude the contractor's liability, it is common for these to be renegotiated by the parties and the extent of their application to be reduced. Unsurprisingly, given the sums of money at stake, exclusions of liability for onsequential losses have proven to be a fertile ground for litigation and merit careful consideration.
 

 

For further information, please contact:

 

Peter Godwin, Partner, Herbert Smith

peter.godwin@herbertsmith.com  
 

 

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