Interpreting caps on liability in construction contracts

A Court of Appeal decision earlier this month has reversed a first instance decision as to whether set-offs should be included within an overall cap on liability. The Court’s finding that set-offs should count toward the cap in this case contrasts with an earlier TCC decision in which recoveries under performance securities were held not to fall within a cap on liability. The earlier TCC decision does not appear to have been cited to the Court of Appeal and the tension between the two cases raises a number of risks and opportunities which parties would be well advised to consider in the drafting of any overall cap on liability.

Topalsson GmbH v Rolls-Royce Motor Cars Ltd

Topalsson and Rolls-Royce entered into a software development contract with the following cap on liability:

“Subject to [exclusions], the total liability of either Party to the other under this Agreement shall be limited in aggregate for all claims no matter how arising to the amount of €5m (five million euros).”

Rolls-Royce terminated the contract for delays by Topalsson and, subject to the cap, was found to be entitled to termination damages of €7,962,323. At the point of termination, Topalsson was found to be owed €794,759 for work carried out. At first instance, the TCC netted these two figures off before applying the cap, meaning that €5 million was awarded to Rolls-Royce.

Topalsson appealed, claiming that Rolls-Royce’s entitlement to termination damages should have been capped at €5 million before Topalsson’s debt was set-off – giving a reduced judgment of approximately €4.2 million.

The Court of Appeal agreed with Topalsson, noting that the words “total liability” suggested “a totting up, not a netting off.” This was supported by the reference to liability “of either Party”, indicating that the liability of each party was to be subjected separately to the cap. The Court also considered that commercial common sense supported this interpretation, as otherwise the cap could be “circumvented by the happenstance of set-off”.

Sabic UK Petrochemicals Ltd v Punj Lloyd Ltd

A TCC decision from 2013 provides an interesting contrast to the Court of Appeal’s decision. It was also a termination for delay case with a liability cap as follows:

“Save [for certain exceptions] the aggregate liability of the Contractor under or in connection with the Contract (whether or not as result of the Contractor's negligence and whether in contract, tort, or otherwise at law) … shall not exceed 20% (twenty per cent) of the sum of the Contract Price …”

The contract permitted the employer, SABIC, to recover the difference between the “total cost … reasonably incurred” in completing the Works and the “total that the … Works would have cost had they been completed by the Contractor (the Contract not having been terminated)”.

Immediately upon termination, SABIC called on a performance bond for £13.5m and an advance payment guarantee for £15 million. Taking these sums into account, and after completing the Works, it had incurred roughly £12 million more than it would have done had the Works been completed by the contractor. The 20% cap equated to approximately £31 million. The contractor claimed that the performance security recoveries of £28.5 million should also count towards the cap, meaning that the contractor’s total liability for termination costs was approximately £40.5 million – and had therefore breached the cap by approximately £9.5 million. 

The TCC rejected this argument, finding that neither of the performance security recoveries counted towards the cap. This was partly because SABIC’s claim under the termination provisions was for the total balance or “extra-over” cost after the Works had been completed. The performance security recoveries avoided the incurring of cost, especially as they were received immediately and used to fund the completion of the Works. They did not, therefore, represent a separate liability to SABIC.

However, the court also found that the nature of the performance securities brought them outside of the cap. They were “a form of proxy for primary performance by SCL” and it was therefore wrong to “assert that all of the expenditure on costs to complete the works was a ‘loss’ without taking account of the fact that provision had been made in advance to obviate that loss”.

Conclusions and implications

The Court of Appeal’s decision provides helpful clarity as to the operation of generally worded caps on liability, however it appears that SABIC was not cited to the Court. Reading the decisions together gives rise to a number of unresolved questions:

• The termination clause in Topalsson did not provide for a single balancing payment, but stated separate rights for Topalsson to be paid outstanding sums due and for Rolls-Royce to be paid the extra-over costs of completion. The decision in SABIC suggests that a different outcome might have applied if the clause provided for a single balancing payment which gave credit for outstanding amounts due to the contractor. However, such a minor change in drafting would then permit the cap to be circumvented in the manner which the Court of Appeal in Topalsson had sought to avoid.
   
• In a similar vein, many construction contracts have detailed interim and final payment provisions which provide for employer claims to be deducted in the calculation of amounts due to a contractor. The reasoning in SABIC may support arguments that such deductions do not represent actual liabilities of the contractor, as they are used only to calculate a single sum due in the same way that a balancing payment on termination gives rise to a single amount owed to an employer. The same circumvention concerns may then arise in relation to these provisions.
   
• The decision in SABIC means that a contractor’s total exposure under a contract will change as performance securities lapse or are stepped down. For example, as an advance payment is gradually repaid or where lower value retention security is substituted for a performance bond upon completion or taking over. This would appear to be at tension with the Court of Appeal’s comments as to the purpose of an overall cap on liability.
   
• It remains to be seen whether other forms of security, such as retention money or parent company guarantees, will be held to fall outside an overall cap on liability – as in SABIC – or within the cap – as in Topalsson.

It seems likely that such questions will require further attention from the Court of Appeal at some point in the future. In the meantime, parties should carefully consider the drafting of any caps on liability within their contracts so as to best protect their position in light of these decisions. Contractors may wish to include specific language making clear that all forms of security (including set-off) are to count toward the cap. Employers, on the other hand, are likely to benefit from the standard form of any cap on liability, but would be well advised to ensure that any termination provisions provide for a single balancing payment and that the payment provisions allow for employer claims to be deducted as part of the valuation of amounts payable to the contractor.

References:

Sabic UK Petrochemicals Ltd v Punj Lloyd Ltd [2013] EWHC 2916 (TCC)

Topalsson GmbH v Rolls-Royce Motor Cars Ltd [2024] EWCA Civ 1330