Net contribution clauses: What you need to know

Most construction professionals will be familiar with net contribution clauses (NCCs) in consultants’ appointments and collateral warranties but their use should not necessarily be limited to the construction sector. They may be useful in any project where professionals from a multiplicity of disciplines are retained.

For example, projects involving high net worth estate planning, complex corporate restructuring, property acquisition, ship building and IT infrastructure projects will often involve several disciplines of professional consultant whose negligence could lead to a single loss to the employer.

Legal advisors representing professionals and their insurers need to know about NCCs. So, what are they and how to they operate?

What is a net contribution clause?

An NCC (sometimes known as a proportionate liability clause) is a contract term which provides that where more than one person in liable for the same damage, the contracting party’s liability will be limited to the proportion of the loss and damage that it is the fair and reasonable (or just and equitable) for the party to pay. In essence, it is a limitation on liability and its purpose is to limit or transfer two key risks:

(a) the 100% liability of a joint tortfeasor; and

(b) the insolvency risk of the other consultants.

Absent an NCC, where two parties are responsible for the same damage, they are jointly and severally liable for the whole of the damage, regardless of the extent of their respective responsibility. A claimant can therefore choose to sue one party for the whole of the damage. In any event, if the claimant is successful, each defendant is prima facie liable for 100% of the damages awarded, regardless of their blameworthiness.

Whilst a defendant in those circumstances may seek a contribution from the other consultants pursuant to the Civil Liability (Contribution) Act 1978, that option is unsatisfactory where the other consultants are insolvent.

NCC clauses address these problems by limiting a party’s liability to the extent of the damage the party may be said to fairly and reasonably be responsible for.

So what’s the problem?

Because NCC’s limit liability they may be found to be unenforceable if they fall foul of (a) the requirement of good faith in regulation 5(1) of the Unfair Terms in Consumer Contracts Regulations 1999 (the “UTCC Regulations”); and/or (b) the requirement of reasonableness in sections 2, 3 and 11 and Schedule 2 of the Unfair Contract Terms Act 1977 (“UCTA”).

However, some useful guidance has been provided in the recent case of Steven and Carol West v Ian Finlay Associates Limited [2014] EWCA Civ 316

West v Ian Finlay Associates [2014] EWCA Civ 316

The Facts

Mr. and Mrs. West (“the Wests”) appointed Ian Finlay Associates Limited (“Finlay”) to act as architect and contract administrator in respect of their £1.7m property development. The Wests contracted directly with the contractor (“Armour”) as well as separate specialists for a conservatory, a spiral staircase, a kitchen and a wooden floor.  On completion of the works, the Wests discovered serious damp and other defects which required remedial works. Finlay and the Armour were both responsible for the damage. Armour became insolvent prior to the issue of proceedings and so the Wests issued proceedings against Finlay for the full extent of the damage. Finlay relied on an NCC which provided as follows :

”Our liability for loss or damage will be limited to the amount that is reasonable for us to pay in relation to the contractual responsibilities of other consultants, contractors and specialists appointed by you.”

The first instance decision

At first instance, Edward-Stuart J held that the NCC did not operate to limit Finlay’s liability and accordingly did not reduce the West's damages to account for the fact that Armour was also responsible for the same damage. The reason for that conclusion was that the Court held the NCC to be ambiguous: “other consultants, contractors and specialists appointed by you” could mean either (a) everyone with whom the Wests entered into a contract with in relation to the project other than Finlay or (b) the various specialist contractors that the Wests intended to enter into contracts with outside the main building contract, which Finlay was retained to administer. Since there was doubt as to the meaning of the NCC, applying Reg. 7 of the UTCC Regulations the court was obliged to give the NCC the interpretation that was favourable to the Wests which was meaning (b). As a result, the NCC did not limit Finlay’s liability where Armour were concerned.

The CA: Interpretation

The Court of Appeal reversed the first instance decision. Reminding the parties that the first consideration was the ordinary meaning to be given to the words, of the NCC, the Court held that the wording was “crystal clear”. The NCC stated that Finlay’s liability for loss or damage was limited to the amount that it was reasonable for it to pay having regard to the contractual responsibilities of the consultants appointed by the Wests and “any other contractor” included any main contractor.

The CA: UTCC Regulations

Finlay having conceded that the contract was not individually negotiated, the Court then considered whether the NCC complied with Reg. 5 of the UTCC Regulations. Restating the test in Director General of Fair Trading v First National Bank Plc [2001] UKHL 52 (per Bingham LJ) that:

“a term is unfair if it causes a significant imbalance in the parties rights and obligations under the contract to the detriment of the consumer in a manner or to an extent which is contrary to the requirement of good faith.”

On the issue of  “significant imbalance” the Court found that the NCC did cause an imbalance because: (i) the NCC grants a beneficial limitation of liability to West while at the same time imposing on the Wests the corresponding risk that, in the case of joint and several liability of Finlay and another contractor, the insolvency of that contractor; (ii) the NCC imposes a procedural disadvantage as the Wests would have to await the outcome of any contribution proceedings before obtaining satisfaction. However, the imbalance could not be said to be significant because: (i) similar NCC clauses are included in standard RIBA forms; (ii) NCC clauses are by no means unusual; (iii) the Wests’ chose their main contractor and, in light of Mr. West’s banking background, would be alive to the importance of Armour’s financial stability.

In any event, the CA held that even were the imbalance significant, the imbalance was not in a manner or to an extent which was contrary to the requirement of good faith. The Court considered Lord Bingham’s description of good faith in First National Bank Plc at [17]:

“The requirement of good faith in this context is one of fair and open dealing. Openness requires that the terms should be expressed fully, clearly and legibly, containing no concealed pitfalls or traps. Appropriate prominence should be given to terms which might operate disadvantageously to the customer. Fair dealing requires that a supplier should not, whether deliberately or unconsciously, take advantage of the consumer's necessity, indigence, lack of experience, unfamiliarity with the subject matter of the contract, weak bargaining position or any other factor listed in or analogous to those listed in Schedule 2 to the Regulations…”

In reaching its conclusion, the CA relied on the finding of Edwards-Stuart J at first instance that Finlay was not “out to take advantage of the Wests” and the Wests could not be regarded as in a weak bargaining position. It is worth noting that the NCC was produced “fairly and openly” in reasonably large print on the third page of a three-page agreement. However, the failure to draw the Wests’s attention to the NCC and its effect was one of the factors which weighed against Finlay in the balance of the “good faith” test.

The CA: UTCA

The UTCA provides that, where a party deals as a consumer or on the others standard terms of business, a party cannot by reference to a contract term, exclude liability for breach save to the extent that any such exclusion is reasonable (s3, s6, s7 and s11 UCTA). The Wests relied on much the same factors in relation to UCTA unreasonableness as they did in relation to the UTCC Regulations. The CA held that the NCC was reasonable as the Wests were in an equal bargaining position, they received no inducement to agree and they ought to have known of its existence as it was placed prominently on the third page of the contract.

Practical tips for legal advisors and professional indemnity insurers

The UTCA provides that, where a party deals as a consumer or on the others standard terms of business, a party cannot by reference to a contract term, exclude liability for breach save to the extent that any such exclusion is reasonable (s3, s6, s7 and s11 UCTA). The Wests relied on much the same factors in relation to UCTA unreasonableness as they did in relation to the UTCC Regulations. The CA held that the NCC was reasonable as the Wests were in an equal bargaining position, they received no inducement to agree and they ought to have known of its existence as it was placed prominently on the third page of the contract.

As will be seen from West v Finlay, many professional bodies such as RIBA now include NCCs in versions of their standard terms. Following West v Finlay, it is likely that such clauses will become more and more common outside the construction sector. For lawyers advising consultants and for professional indemnity insurers, insisting on NCCs limiting liability in standard terms can help consultants manage their liability and thereby reduce their insurance premiums and professional fees.

However, enforceability issues are likely to continue to arise. Legal advisers should bear the following points in mind:

1. Enforceability is fact specific. In each case issues of “significant imbalance”, “good faith” and/or “reasonableness” need to be looked at in the context of the contract as a whole.
2. Consultants should ensure that the NCC is featured clearly and prominently in any contract.
3. Parties who wish to rely on an NCC should bring the NCC to the attention of the other party before entering into the contract.
4. If a party intends to or is required to give any collateral warranties, the NCC must be included in the collateral warranty as well as the main contract in order to be effective.
5. An NCC should set out clearly the contractors and consultants (or classes thereof) to which it is intended to apply.