Choosing the law that applies to commercial contracts is an essential consideration with a significant impact on issues such as good faith and the extent of the parties’ liability
The interpretation of commercial contracts varies across jurisdictions. In this Insight, we examine how the position on contractual issues such as good faith, endeavours obligations, warranties and representations, indemnities, and entire agreement clauses varies in the UK, France, Germany, the Netherlands, Spain and Poland, and also consider how contractual liability can differ.
Is a duty of good faith implied into the performance of commercial contracts?
There is no general duty of good faith implied into the performance of all commercial contracts.
But a duty of good faith may be implied into relational contracts, for example, long term contracts where the parties are committed to collaborating with each other and where they put trust and confidence in each other, such as joint ventures, franchise agreements, and long term distribution agreements.
However, the “relational” concept is likely to be interpreted narrowly and the courts are also likely to apply the general test for implied terms, with a duty of good faith unlikely to be implied unless the contract lacks commercial or practical significance without the term, or the term was so obvious it went without saying.
(Note that this Insight does not cover duties of good faith arising in specific contexts, such as the pre-contractual duty of utmost good faith relevant under English law to some insurance policies.)
There is an explicit duty of good faith in all commercial contracts by virtue of article 1104 of the Civil Code, and this duty applies to all contracts of any nature that are subject to French law.
The duty of good faith applies to all stages of a contract’s life, from negotiation to execution and performance. This duty cannot be waived by the parties contractually.
Contracting parties are presumed to be acting in good faith. The burden of proof in relation to breach of the duty of good faith lies with the claimant.
Yes, a duty of good faith is implied into all contracts as a matter of statutory law.
This duty extends to the pre-contractual and negotiation phases as well, and can limit the enforceability of contractual provisions.
Good faith forms a general principle that applies to all contracts. The relationship between parties (even in the pre-contractual and negotiation phases) is governed by this principle.
A party to a contract cannot enforce a contractual obligation or right, if it would be considered unfair or unreasonable to do so under the then current circumstances.
The Spanish Civil Code imposes a general duty of good faith on contracting parties.
This duty of good faith is required of the parties at all stages of the contracting process, including the negotiation phase, regardless of the type of contract in question. The duty applies even in the event of breach of contract where the injured party is expected to mitigate its losses.
Good faith is a notion which is particularly relevant in pre-contractual arrangements or when ascertaining damage.
Under Polish law, good faith is not relevant for the assessment of the execution or due performance of commercial contracts.
In the Polish legal system, the role of “good faith” tends to be covered by express general clauses, which refer to moral standards and assessments. These clauses require the parties to comply with moral principles, principles of fairness, and principles of community life.
However, the duty of good faith is relevant to the precontractual and negotiation phases, and it can limit the enforceability of contract provisions.
What does “good faith” mean?
Good faith does not simply mean “honesty”, it means refraining from conduct which would be regarded as commercially unacceptable by reasonable and honest people.
Transparency, co-operation, trust and confidence are implicit.
When it is established that a party’s actions are subject to a duty of good faith, the following minimum standards are likely to apply:
- they must act honestly;
- they must be faithful to the parties’ agreed common purpose;
- they must not use their powers for an ulterior purpose;
- they must deal fairly and openly with the other party;
- they can consider and take into account their own interests but must also have regard to the other party’s interest.
In practice, the notion of good faith is multifaceted and is determined on a case-by-case basis by the courts. Good faith is increasingly used by the parties to renegotiate a contract, especially in the event of an exceptional situation such as inflation, war or Covid-19.
The duty of good faith covers a wide range of obligations that vary depending on the stage of a contract’s life such as an obligation to co-operate, to act loyally, to ensure confidentiality and to disclose information.
Acting in good faith means dealing in a way that would be ethically acceptable to reasonable and fair people and takes into account the interests of the counterparty.
Whether or not certain conduct breaches the duty of good faith will be determined on a case-by-case basis. There is an abundance of case law on this subject.
Depending on the circumstances, it can, for example, be considered bad faith to abuse bargaining power, to mislead in negotiations, to fail to meet expectations, or to exercise a right in an abusive way.
Some concepts originally based on the general duty of good faith have also been codified, such as a right to require adjustments, or termination, in the event of a fundamental change in circumstances for which neither party is responsible.
The meaning of good faith is aligned with the Dutch law principles of reasonableness and fairness, so a party must act reasonably and fairly towards the other contracting party.
The principle also applies during the pre-contractual and negotiation phases.
Dutch law gives a negative understanding of good faith: a person has not acted in good faith, if he knew, or in the circumstances ought to have known, the facts or the law on which his good faith depended. Under Dutch law, a party bases its good faith on certain facts or circumstances and, if that party is ill-informed, then that party is considered not to be acting in good faith. The implication is that a party may be under a duty to investigate.
There is no definition of good faith under Spanish law.
However, it can be defined as integrity and honesty in behaviour, in a way that makes the behaviour reasonable, predictable and shows that a party has acted in line with, and towards reaching, the aims set out in the contract.
Good faith is a concept that is determined on a case-by-case basis. For example, Spanish case law considers that a party to a contract should act in a way that is consistent with how it has acted in the past.
There is no standard definition of good faith provided by statute or case law.
The concept of good faith is multi-dimensional and is determined by the courts on a case-by-case basis. Good faith is acknowledged to be a justifiable ignorance of the true position – usually the existence of a legal connection or right. As a result, good faith consists of three components: (i) the conviction that a right or legal connection exists (or does not exist); (ii) the error in this conviction; and (iii) the possibility of justifying the error given the circumstances.
The duty of good faith encompasses a wide range of obligations that vary based on the stage of a contract’s life, including the responsibility to co-operate, act loyally, maintain secrecy and disclose information.
What is the meaning of “reasonable endeavours”?
The question to ask is: what would a reasonable and prudent person acting properly in their own commercial interest and applying their minds to their contractual obligation have done to try to achieve the objective?
Crucially, the obligor is not normally required to sacrifice its own commercial interests and commonly only has to take one reasonable course of action.
This can be compared with an obligation to use “all reasonable endeavours”. This may require a party to exhaust all reasonable paths or actions and “some subordination of commercial interests” may also be required. It therefore seems that the “all reasonable endeavours” obligation has moved nearer to the more stringent “best endeavours” obligation.
The concepts of reasonable endeavours and best endeavours are not recognised under French law.
Under French law, one uses “obligation de résultat” which translates as the obligation to obtain a certain result, or “obligation de moyens” which translates as the obligation to implement the means necessary to obtain a certain result.
References to “reasonable endeavours” or to “best endeavours” in a contract subject to French law would in all likelihood achieve the same result. Both terms would likely be considered as an “obligation de moyens” because they are not absolute obligations requiring the relevant party to achieve a certain result, but instead they require that party to implement a certain standard of means necessary to achieve such result.
There is no universal definition of the term “reasonable endeavours”.
Depending on the type of contract, the parties may either owe a result (regardless of how hard they tried), or an endeavour.
To analyse whether an endeavour is sufficient, German courts would take all circumstances into account, including the associated cost and effort, the state of the art where applicable, and the relationship between the required effort to achieve the goal and the importance of the goal itself.
The term “reasonable endeavours” has no clear meaning under Dutch law. It can be considered to be part of the obligation to perform to the best of one’s ability.
Such an obligation will be interpreted in accordance with the so-called Haviltex-formula (based on settled Dutch case law), which is intended to fill any gaps in a contract based on the parties’ intentions and reasonable expectations.
There is no definition of the term “reasonable endeavours” in Spanish law beyond the notion of good faith.
In “activity” obligations (for example, software maintenance), it is likely to be interpreted to mirror the notion of “standard care”, which is normally presumed.
In “results” obligations (for example, specific software development), it is likely to be less meaningful as the mere act of attempting will not be sufficient to achieve the requirements of the contract.
The concepts of “reasonable endeavours” and “best endeavours” are not recognised under Polish law.
Article 355 of the Polish Civil Code introduces the concept of due diligence/care. Due care is defined as a specific course of action designed to result in performance; a specific model, a pattern built from conduct standards (duties). It is about positive behaviour; the term “diligence” here is a synonym for adjectives like careful, precautionary, prudent, attentive and reasonable. Due diligence should be applied to the unique situation.
Other than businesses, the additional due diligence norm can be applied to professional organisations, such as doctors.
Polish courts would consider all factors when determining whether an endeavour is sufficient, including the accompanying expense and effort, the state of the art when relevant, and the relationship between the required effort to achieve the goal and the importance of the goal itself.
Moreover, Polish law requires “zobowiązania rezultatu” which is the obligation to obtain a certain result and “zobowiazania starannego działania” which means that the party is obligated to implement certain standards in order to achieve the result.
What is the meaning of “best endeavours”?
Best endeavours may require the obligor to act contrary to its commercial interests and/or require expenditure by the obligor. In Jet2.com v Blackpool Airport Ltd the court held that an obligation on the airport to use best endeavours to promote the airline’s low-cost services required the airport to open outside of its normal working hours (to accommodate the airline’s early morning and late evening flights) despite the airport incurring a loss in doing so.
However, all “endeavours” obligations will be assessed on a case-by-case basis, taking into consideration the precise wording of the contract and the context in which that wording arises.
Please see comments above on reasonable endeavours.
There is no universal definition of the term “best endeavours”. The analysis carried out by a German court would be similar as for “reasonable endeavours”, but less weight would likely be given to an argument that a specific action was not required because it was too onerous.
As set out above, the term reasonable endeavours has no clear meaning under Dutch law.
There is no concrete difference between “reasonable” and “best” endeavours. The interpretation of these terms depends on the circumstances of the case and their meaning will be determined by the court.
As indicated in relation to “reasonable endeavours”, the term “best endeavours” has not been defined under Spanish law beyond the notion of good faith.
As above, in “activity” obligations (such as software maintenance), it is likely to be interpreted to mirror the notion of “standard care”, which is normally presumed.
In “results” obligations (such as specific software development), it is likely to be less meaningful as the mere act of attempting will not be sufficient to achieve the requirements of the contract.
The concepts of reasonable endeavours and best endeavours are not recognised under Polish law.
See comments above on reasonable endeavours
Is there a difference between a “warranty” and a “representation”?
Yes, there is an important difference.
A warranty in a commercial contract is, in its technical sense, a contractual assurance from one party to the other. Breach of a warranty gives right to a claim for damages but not usually the right to terminate.
A representation is a pre-contractual statement which induces the other party to enter the contract. Use of the term in a contract is the repetition of a pre-contractual statement. If the representation is false, and induced the contract, the following remedies for misrepresentation are likely to be available:
- Rescission: the contract is set aside and treated as if it never existed. The parties are restored to the position they were in before the contract was made; and/or
- Damages: which may be higher than damages for breach of contract, and are calculated on a different (tortious) basis.
(Note that this Insight does not cover the interpretation of warranties in other specific contexts, such as insurance contracts, where the position is different from that outlined here in relation to commercial contracts.)
The concepts of warranties and representations are not recognised under French law.
However, similar concepts are used in the context of contracts relating to transactions or financing under the wording “declarations et garanties”. “Declarations” (“representations”) are statements related to factual or legal situations that are usually embodied in a Share Purchase Agreement. The purpose of “garanties” (that is, “warranties”) is to indemnify the other party in the event of a misrepresentation or omission relating to the “declarations” given.
One of the key distinctions when drafting contractual obligations under French law is the distinction between “obligation de résultat” and “obligation de moyens” as outlined above.
German law does not distinguish between warranties and representations in the same way as UK law.
Rescission or termination are available for most breaches (albeit sometimes only where the counterparty fails to remedy the breach within a reasonable cure period).
However, there is an important distinction between two German law concepts that can be hard to express in the English language: “Gewährleistung” is a statutory system of remedies that are available under German law but which can be contractually modified. Some of these statutory remedies are triggered only if the breaching party is negligent (or acting intentionally, which represents a higher level of responsibility under German law), while others are available even where the breach occurs with no negligence. These statutory remedies are often referred to as a “warranty” in English language drafts under German law.
“Garantie” on the other hand implies unlimited, strict no-fault liability on the part of the breaching party. This is sometimes referred to as “representation and warranty” in English language drafts under German law.
It is important to note that both “Garantie” and “Gewährleistung” can be translated into English as “warranty” and therefore additional wording is strongly recommended in contracts to avoid ambiguity.
Dutch law does not clearly distinguish between warranties (“garanties”) and representations (“feitelijke mededeling”).
A “Representation and warranty” clause can be interpreted in two ways, namely as:
- A contractual obligation of a party that the (important) information provided is true and accurate; and/or
- A contractual warranty (in Dutch, “garantie”) that, if breached, will oblige a party to cover the damage caused.
Breach of such clauses can entitle the other party to different remedies, namely:
- Rescission of the contract based on error (“dwaling”); and/or
- Either: (a) a claim for performance (which is often the remedy first sought under Dutch law); (b) termination of the contract based on non-conformity and/or default; and/or (c) a claim for damages.
Warranties and representations are not specifically regulated under Spanish law.
In Spain, contractual parties are protected by a two-fold “ex lege” warranty which states that the object of a purchase agreement must be: (i) free from encumbrances; and (ii) free from hidden defects.
Encumbrances normally lead to compensation for the costs of the agreement and not for other additional damage. Hidden defects require a party to prove wilful misconduct and usually only relate to the most serious damage.
Furthermore, “error” – being a fault affecting the willingness to enter into the contract – may cause the contract to be null and void and may lead to the contract having no effect.
For the contract to have no effect, the following requirements need to be met:
- the error must relate to the object of the contract or to one of its essential elements, that is, those objects which led the parties to enter into the contract;
- the error cannot be attributable to the person who suffers as a result of it; and
- the error must be excusable, that is, unavoidable if acting with standard care.
Representations and warranties are not regulated in Polish law, however they are recognised under Polish law and contractual practice.
Currently, drafting representations and warranties in one of four legal structures does not result in serious disagreements. Those four structures are:
- a guarantee obligation;
- statutory warranty;
- contractual liability; and
- an error.
However, there is an ongoing discussion on determining the legal effects of representations and warranties contained in a contract which does not simultaneously determine the consequences for parties if their representations and warranties prove inaccurate.
Furthermore, Polish contractual law also provides for distinctions between “zobowiązania rezultatu” and “zobowiazania starannego działania” as outlined above.
Is it important to include an “entire agreement” clause in commercial agreements?
Yes, because without such a clause, there is a risk that statements made during negotiations which are not included in the final agreement, may constitute additional terms or representations.
A clause generally consists of a number of different elements:
- Entire agreement statement: To prevent the presumption that the written agreement contains all the terms of the contract from being displaced.
- Exclusion of liability for misrepresentations: Most commonly a non-reliance statement, to prevent liability in misrepresentation arising, by creating a contractual estoppel.
- Express carve-out in respect of fraud: Not legally necessary but usually included.
Yes, it is advisable to include an entire agreement clause in order to prevent the presumption that other contractual terms might apply such as general terms of sale or previous agreements entered into between the parties.
There is no standardised language used in order to achieve this result.
It does not hurt to include an “entire agreement” clause, and it can help an argument that standard terms or other documents not referenced in the agreement were not meant to apply.
Such a clause will not, however, prevent a German court from drawing on statements made during negotiations to interpret ambiguous clauses or fill in gaps in the agreement.
Therefore, it is harder to prevent pre-contractual statements from forming part of a written agreement under German law than under English law.
The Dutch courts have ruled that an entire agreement clause has no special meaning under Dutch law.
Such a clause will not prevent Dutch courts from taking into account pre-contractual statements and the parties’ intentions and reasonable expectations before, during and after entering into a contract. However, the parties’ intention to include such a clause will also be taken into account by the court when considering the arguments of both parties.
As a result of freedom of contract, the parties may freely determine the provisions of contracts, provided that it does not contravene Spanish law or public order.
An entire agreement clause would not prevent Spanish courts from interpreting the agreement in accordance with previous documents or contracts or statements between the parties.
Under Spanish law, any aspect which is regulated by legislation and is not expressly regulated in a specific contract, will be interpreted according to the respective legislative provisions (for example, the general regime of damages in the Spanish Civil Code).
In addition, judges and courts tend to be freer than elsewhere when it comes to interpreting whether a given clause affects the whole agreement or not, by ascertaining the balance of the contract, intention of the parties, and so on.
The parties to a contract may rely on an “entire agreement” clause as evidence that the parties intended the contract to be understood as submitted, in the absence of evidence to the contrary. When included in a contract, this clause may effectively limit the parties’ rights and obligations under the contract. This is mainly because the parties are entitled to shape their legal position themselves on the basis of freedom of contract. It can support a claim that there was no intention to use standard terms or other materials which were not mentioned in the agreement.
However, such a clause does not prevent a Polish court from using statements made during negotiations to interpret unclear clauses or fill gaps in the agreement.
What losses are recoverable at law following a breach of contract?
Not all losses that flow from a breach of contract are recoverable. The party in breach is responsible for:
- First limb (direct losses) – losses “arising naturally … from the breach of contract“;
- Second limb (indirect losses) – losses which “may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract“.personal;direct;actual; certain; and lawful.
There is therefore potential for enormous liability and so parties commonly seek to impose limitations.
There have been a number of cases where all of the losses suffered by the claimant were held by the court to be direct losses and the contractual exclusion of indirect losses did not restrict the claim.
Under French law, only direct damages (that is, damages which directly stem from the contractual breach) are indemnifiable and recoverable at law.
French law only distinguishes between direct and indirect damages: those which are recoverable (direct) and those which are not (indirect).
Any recoverable damage must be:
- certain; and
Thus the concepts of “consequential”, “incidental”, “special” and “punitive” damages are not applicable under French law and would not be awarded by a French court.
French case law generally adopts a conservative approach in assessing damages. Unless the contract provides otherwise, French courts tend to limit the damages that may be granted to a party which has suffered harm due to the other party’s breach or failure under an agreement only to those material damages resulting directly and immediately from the breach or failure.
Typically, loss of business, loss of revenue and any consequential damages are not deemed to be “direct damages” and are generally not recoverable (although this will be assessed on a case by case basis).
However, it should be noted that it is possible to define contractually what constitutes indirect and therefore non-recoverable damages. Parties are advised to set out expressly what constitutes indirect damages when drafting a contract in order to avoid argument later on in court.
Losses which are “recoverable” under French law are often referred to as “indemnifiable” losses; and those which are “non-recoverable” are referred to as “non-indemnifiable”. This does not mean that the losses are recoverable in the manner that they would be under an indemnity claim under English law.
Generally, all losses caused by a breach are recoverable by the innocent party, including loss of profits, loss of goodwill and other losses that might be considered “indirect” under English law. German law has no clear distinction between direct and indirect losses. Some limits apply, for example, legal fees can usually be recovered only up to the statutory amount.
However, as a general rule the innocent party must prove the amount of its loss. Under certain circumstances, a court can make estimates; and specific calculation methods exist for intellectual property infringements that make it easier for the injured party to recover substantial damages.
German law does not award punitive damages and, as a matter of law, German courts do not enforce foreign punitive damage awards.
Following a breach of contract (or tort), a party is entitled to compensation for those losses that are closely connected to and caused by the fact on which the liability claim is based. This causal connection is established by weighing the nature of the liability (being strict liability or liability based on negligence) and the damage, and whether the damage can reasonably be attributed to the fact at hand.
There is no predetermined calculation method for damages for breach of contract. A judge has considerable freedom to calculate or even estimate the damages and may include, for example:
- financial loss;
- loss of profits; and
- reasonable costs incurred in order to (i) prevent and limit damage; (ii) assess the damage and liability; and (iii) establish the claim in court.
Under Spanish law, contractual liability is limited to damages that are the immediate and direct consequence of the breach.
The party claiming damages must exhaustively prove:
- the existence of damage;
- the cause-effect relation between the breach and the damage; and
- the quantum, since such party bears the burden of proof.
In general terms, damage is the sum of:
- general losses (“daño emergente“); and
- loss of profits (“lucro cesante“).
In the case of breach of contract (or tort), a party is entitled to compensation for damage resulting from a debtor’s non-performance (that is, contractual liability). The prevailing view provides that only pecuniary damage (damage which expresses itself in unfavourable consequences for the creditor’s property) may be compensated.
Under Polish law, there are two forms of damages:
- Loss which occurs when assets are depleted as a result of incorrect fulfilment of a duty; and
- Lost profits which occur when, as a result of the debtor’s misconduct, the creditor did not gain the benefits that it could have expected in the usual course of events.
Punitive damages are not awarded under Polish law, and Polish courts do not enforce international punitive damage awards.
In general, the claiming party must demonstrate the extent of its loss. A court can adopt estimates in some instances, such as when it is impossible to prove the exact amount of contractual damage.
What is a common B2B liability position regarding risks each party is commonly willing to accept on an unlimited basis?
Risks which cannot be limited or excluded at law (or due to public policy would not be enforceable):
- death/personal injury caused by negligence;
- fraud/fraudulent misrepresentation;
- breach of the implied term that a seller has a right to sell the goods it is selling.
It is common for a party to seek unlimited liability for the following liabilities:
- confidentiality breaches;
- breach of an anti-bribery clause;
- wilful default and abandonment; and
- some indemnities, for example, third party intellectual property (IP) rights infringement.
Liability for wilful misconduct, fraud, gross negligence, and/or liability for death or bodily injury (even in the absence of negligence) cannot be limited under contract. Any such limitation will not be enforceable.
Limitation of liability in the event of third party claims for IP infringement and breach of data obligations is possible but not usual in French contractual practice.
In standard form agreements, liability can be excluded only to the following extent:
- liability must be unlimited for intent (which includes fraud), gross negligence, personal injury, and under mandatory statutes (such as the German Product Liability Act);
- liability can be limited to typical and foreseeable damage for simple negligent breaches of essential obligations; and
- liability can be excluded for simple negligent breaches of non-essential obligations.
(Note that, unlike under English law, there are different levels of negligence under German law – including simple and gross negligence – and that the term “negligence” does not describe a specific type of unlawful conduct, but the level of responsibility for a consequence, whether that consequence is a breach of contract or damage caused to another person outside or independently of a contractual relationship).
The wording of limitation of liability clauses needs to follow additional formal requirements, and therefore legal advice in drafting is strongly recommended.
Liability for: intent (“opzet“); and gross negligence (“bewuste roekeloosheid“) cannot be excluded or limited under contract. Any such limitation will not be enforceable.
Limitation or exclusion of liability by contract must never be contrary to good morals or maintaining public order, or unacceptable according to the standards of reasonableness and fairness.
In Spain, liability cannot be limited nor excluded for:
- wilful misconduct (“dolo“);
- tort (as it refers to extra-contractual liability: “responsabilidad extracontractual“); and
- gross negligence (“culpa o negligencia graves“).
A party to a B2B (business-to-business) contract is potentially liable for non-performance or improper performance of contractual services up to the entirety of its assets.
The parties to the B2B contract have the option of changing this position, that is, extending or limiting their legal liability, by including clauses in the B2B contract. Additionally, the parties may simplify the recovery of damages for unlawful performance.
However, the parties must remember the principle of contract freedom, which states that B2B contract stipulations may not be opposed to the law, the nature of the connection in question, or the norms of social coexistence.
Under the Polish Civil Code, it is also impossible to exclude liability for intentional damage.
What is a common B2B liability position regarding risks each party may seek to wholly exclude?
Commonly, all indirect losses are excluded (though may be expressly accepted in relation to an indemnity).
Other heads of loss may be wholly excluded depending on bargaining position such as loss of profit, revenue, data, wasted costs and anticipated savings.
Each party should be mindful to leave the other party with a meaningful remedy.
As noted above, it is possible to define contractually what constitutes indirect damages under a particular contract and parties are advised to set out expressly what constitutes indirect, and therefore irrecoverable, damages when drafting a contract in order to avoid later argument.
To the extent that a cap on direct damage is included in a contract, such cap can be challenged in the courts if it “substantially deflates the purpose of the agreement” (please see the following section on caps).
The above position has also become a de facto standard for individually negotiated agreements, even though more stringent limitations are legally possible.
Liabilities generally excluded are:
- indirect or consequential losses; and/or
- certain types of losses related to specific risks included in the contract which would be considered indirect under common law.
Please note that the concept of indirect loss is not defined under Dutch law, nor well developed in Dutch case law. It is best practice to specify in the contract exactly which types of losses are recoverable and which are excluded
Under Spanish law, the exclusion of indirect and consequential damages does not limit a party’s liability for loss of profits that are an immediate and direct consequence of a breach.
When drafting a contract, it is advisable to expressly exclude: loss of profits, loss of contracts, loss of opportunities, loss of anticipated revenues and loss of anticipated savings.
In any event, Spanish law does not provide for a closed classification of consequential or indirect damages. Their determination will depend on the specific case, and it will be inferred from the nature of the contract (for example, loss of savings is normally an indirect damage, unless it was part of the subject matter of the contract).
B2B contracts involve a high degree of contractual freedom. Therefore:
- Liability for product defects in a B2B contract can be limited or entirely excluded.
- Warranties may be limited or even excluded.
Damage types can be specified. In the absence of contractual provisions to the contrary, a party will be liable for the damage suffered by the counterparty and for the benefits he has lost as a result of the damage.
Common liability caps in B2B contracts
Limit/cap on remaining risks, for example:
- aggregate agreement;
- annual caps;
- fixed monetary caps;
- fixed percentage of fees; and
- “greater of” formulations.
It is important to note that tortious liability cannot be limited by way of contract.
It is possible to limit contractual liability for breach of contract under French law provided that such limitation does not “deflate substantially the purpose of the agreement”. A limitation may be held to substantially deflate the purpose of the agreement if it results in the breaching party being exposed to no real sanction as a result of that breach. This concept is assessed by the courts on a case by case basis.
A liability cap which is equal to the amount paid during the prior 12 months is usual practice in agreements subject to French law.
Depending on the parties’ bargaining power, individually negotiated agreements may also contain:
- an exclusion of all liability for simple negligence;
- a cap on liability for simple negligence (often a percentage of “fees paid” or “fees paid or payable in the contract year in which the damage occurs”, but also specified amounts); and/or
- a cap on liability for gross negligence (though this is less common).
Common liability caps:
- aggregate agreement;
- annual caps;
- fixed monetary caps;
- fixed percentage of fees;
- “greater of” caps; and
- may reflect the insurance position.
Limit/cap on remaining risks:
- aggregate agreement;
- annual caps;
- fixed monetary caps;
- fixed percentage of fees;
- “greater of” formulations.
Doctrine and case law agree that, in the system of contractual liability, it is not possible to exclude liability in a contract for damage that is done on purpose to the counterparty.
In terms of all other liability, the parties are generally free to shape the scope of liability in the event of non-performance or improper performance of the contract’s obligations as they choose.
Caps for specific losses
Separate or “super” caps for specific losses:
- Most commonly seen for loss or damage to property risks. May reflect insurance position.
- May also be seen for data protection risks.
- May be seen in the event of wilful default and abandonment.
Be clear on whether or not individual caps are cumulative.
Separate caps are becoming more and more common for data protection breaches.
Separate caps for specific types of losses are possible, especially in individually negotiated agreements, but they are less common.
More commonly, some types of losses, such as related to data protection or intellectual property infringements may be carved out of otherwise agreed caps.
Separate caps for specific losses:
- Data protection risks (for example, twice the normal cap);
- Infringement of intellectual property rights (which is often uncapped).
Separate caps for specific losses:
Commonly seen for specific areas of concern depending on the nature of the contract (for example, data protection, intellectual property).
There is no standard position in relation to separate caps for specific losses.
Expressly recoverable losses
Expressly recoverable/expressly excluded losses:
- Customer: best practice to state any losses which can be recovered as express direct losses, for example, costs of selecting new supplier.
- Supplier: best practice to state any specific heads of loss which are irrecoverable.
There is no standard position in relation to losses which are expressly stated in commercial contracts as being recoverable, or excluded, and this is contract-specific.
Please see our comment regarding indirect loss under “Liability generally excluded”.
Please see above.
There is no standard position in relation to losses which are expressly stated in commercial contracts as being recoverable or excluded: this is contract-specific.
What are the perceived advantages of an indemnity?
Belief that getting an indemnity gives quicker, easier and fuller recovery than available for breach of warranty because:
- Once the relevant event occurs, the obligation to pay is enforceable by means of a debt action;
- The contract principles of causation and foreseeability do not apply to debt actions; and
- The indemnified party has no general duty to mitigate its loss.
However, case law is not consistent, and sometimes causation and remoteness may apply to an indemnity claim. Each indemnity will be construed in accordance with its language. Recovery under a particular indemnity will depend on its drafting and the context, and express drafting should be used to achieve the desired result.
Indemnity clauses are not common practice under French law, and do not make recovery easier.
No specific course of action exists under French law as regards enforcement of indemnity clauses and the indemnified party would have to go through standard proceedings in the French courts to enforce an indemnity clause, as it would in order to enforce a standard contractual clause.
Depending on the drafting, an indemnity is often considered a guarantee under German law, implying no-fault liability on the part of the breaching party where – without this wording – statutory law would usually require at least negligence in order to trigger a damages claim. This means that, broadly, it can be easier to make a claim under an indemnity, which can be deemed to be a guarantee under German law, because there is no requirement to demonstrate negligence or default by the breaching party.
An indemnity obligation can also be drafted to:
- limit other defences the indemnifying party may have (for example, if made payable “upon first request”, it has to be paid, regardless of any defences which may only be invoked in a lawsuit for repayment); and/or
- extend the recoverable loss (for example, market-rate legal fees instead of only the statutory fees).
Indemnities are tools to allocate responsibilities absolutely, often without regard to culpability.
An advantage is that the indemnified party will in most cases only have to show breach of the indemnity to recover all losses caused thereby.
There are no statutory rules governing indemnity clauses. The wording of the indemnity determines the scope of losses that are recoverable. Precise drafting is therefore absolutely essential.
There is no specific way of enforcing indemnity clauses under Spanish law.
If the indemnity clause is breached, in the absence of a specific procedure, the same remedies will have to be pursued before the Spanish courts as in the case of an ordinary clause. This means that agreeing an indemnity does not grant the benefit of a “debt action” for the indemnified amounts, because it may, for instance, be declared imbalanced by a court.
Depending on the phrasing, an indemnity is frequently seen as a promise under Polish law, implying no-fault culpability on the part of the breaching party where statute law would normally need at least carelessness to trigger a claim.
The starting point of an indemnity clause in Polish law is the principle of freedom of contract.
Article 392 of the Polish Civil Code provides that a third party may undertake, by agreement with the debtor, to release it from its obligation to perform the contract, and, as a result of accepting such an obligation, become responsible to the debtor for the fact that the creditor will not demand performance of the contract from it.
Under Polish law, there is no unique course of action for enforcing indemnity clauses, and the indemnified party would have to go through standard processes in Polish courts to enforce an indemnity clause, just as it would for enforcing a standard contractual clause.
Because there are no specific regulations controlling indemnity provisions, accurate drafting is crucial.
What do the parties need to look out for when agreeing liquidated damages provisions?
If the provision is found to be a penalty, it will be unenforceable.
A penalty is a contractual provision which imposes a detriment on the party in breach of a primary obligation which is out of all proportion (or extravagant or unconscionable) to any legitimate interest of the innocent party in the performance of that obligation.
When agreed by sophisticated commercial parties, of equal bargaining power, a liquidated damages clause does not need to be negotiated in minute detail, nor be an accurate pre-estimate of the loss in fact suffered, in order to avoid being an unenforceable penalty.
Liquidated damages will likely only be held to be an unenforceable penalty if they are exorbitant or extravagant when compared with the greatest loss likely to be suffered.
Parties may consider drafting conditional primary obligations, rather than drafting for liquidated damages to be payable in the event of breach.
French law does not draw a distinction between penalty and liquidated damages clauses.
Under French law a penalty or liquidated damages clause, a “clause pénale“, aims to ensure that the relevant party will perform the obligation, subject to the application of the penalty. Failure to do so will result in the payment of the penalty as a form of pre-determined damages.
This type of clause must be carefully drafted so that it is not considered to be a limitation of liability clause or a forfeiture clause (where a party can agree in advance to pay a certain sum in return for the right to disengage from an obligation or from an agreement before its performance).
This is of importance as a judge has the power to increase or decrease the amount of the penalty in a “clause pénale” that it deems either obviously insufficient or excessive, whereas in relation to a limitation of liability clause or a forfeiture clause, a judge cannot amend the level of the liability cap or the agreed sum and can only declare the clause void where the relevant conditions are met.
Contractual penalties are enforceable under German law, but are subject to reduction by courts if they are excessively high. It is also possible to agree that the injured party determines the amount of the penalty in good faith (taking into account the severity of the breach), but also subject to court review.
Liquidated damages must be based on a good faith estimate of what the typical actual damage would be.
Additional restrictions apply in standard terms: the breaching party must expressly have the opportunity to prove that the actual damage was lower than the liquidated damages (in which case the breaching party only owes the actual loss suffered).
Under Dutch law, both liquidated damages clauses and penalty clauses are considered lawful. A penalty clause can be used: (i) as an incentive to perform; and/or (ii) to liquidate damages.
Unless expressly agreed by parties, a penalty clause will replace: (i) any claim for damages; or (ii) performance of the contract (unless the penalty clause only serves as a form of compensation for losses due to delays).
However, penalty clauses and liquidated damages are still subject to the principles of reasonableness and fairness and may be limited by the courts. The party relying on a penalty clause and intending to collect the penalty from its counter-party, must state and prove that there is an (attributable) breach of contract. The court has a right to reduce the level of a penalty set out in a contract. The judge may only use its ability to intervene sparingly, and is most likely to do so if there is a huge discrepancy between the fixed amount and damages suffered. Parties cannot exclude this mitigation by the court in an agreement.
A penalty clause (“cláusula penal“) is a regulated term under the Spanish civil and commercial codes, that equates to liquidated damages under English law.
The “cláusula penal” needs to be expressly agreed in the contract and invoked to take effect. It has the following effects:
- it will replace any other compensation for damages and default interest; and
- the party that suffers the damage will not have to prove damages neither their quantum.
Under Spanish law, a judge or court may moderate the penalty contractually agreed by the parties. However, the judge or court will not moderate the amount of the penalty clause so that it is proportional to the damages caused, but so that it is proportional to the degree of performance of the obligation.
Therefore, it would not be a matter of moderating an excessively high penalty, but of reducing it in proportion to the degree to which the main obligation has been fulfilled.
Under Polish law, both liquidated damages clauses and penalty clauses are considered lawful.
However, a contractual penalty has far more serious effects for the counterparty than a liquidated damages clause.
Contractual penalties are penalising and disciplinary in nature, rather than compensatory. If any party suffers loss as a result of the contract’s non-performance or faulty performance, the other party is obligated to pay the amount specified in the contract. This means that the parties might specify in the contract that the damage will be remedied through payment of the agreed-upon amount.
A judge has the power to increase or decrease the amount of the penalty in a “kara umowna” that it deems either obviously insufficient or excessive.
On the other hand, a liquidated damages clause is intended to estimate damages in the event of non-performance or breach of contract. A liquidated damages clause will be enforced where the court finds that the harm caused by the breach is difficult to estimate, but where the amount of liquidated damages is reasonable compensation for the actual damage.
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