A Net Contribution Clause or “NCC” limits a contractor’s liability to losses for which it is responsible. Its aim is to avoid one contractor being jointly and severally liable for the whole of the claimant’s losses.
The Court of Appeal in West v Ian Finlay decided that an NCC, if clearly drafted, is likely to be considered fair and reasonable. It will not be considered unreasonable or ineffective simply because it avoids the principle of joint and several liability.
In summary the Court of Appeal held that:
Suppliers should consider including an NCC in their contracts where other contractors or consultants are engaged. The clause should be clear and easy to understand. On the other hand, buyers faced with an NCC should give careful consideration to the financial position of all the contractors involved.
Although the case related to a building project, it is of application wherever work is done by one or more contractors.
The case arose following improvement and renovation works done to a property in Putney, owned by a Mr and Mrs West. A number of contractors were involved in that work. The main contractor was Armour. The defendant, Ian Finlay Associates (“IFA”), was the architect/contract administrator, responsible for coordinating the work done by the various contractors.
After the work was completed, there was considerable damp in the house, which necessitated extensive remedial works. Much of the defective work was done by Armour, but Armour had gone into liquidation. The Wests, therefore, sued IFA to try to recover what they could not recover from Armour.
IFA relied on the NCC to limit its liability to the Wests on the basis that Armour had also been at fault. The NCC provided that: "Our liability for loss or damage will be limited to the amount that it is reasonable for us to pay in relation to the contractual responsibilities of other consultants, contractors and specialists appointed by you."
A NCC attempts to apportion liability to the claimant, as between wrongdoers, in accordance with their actual responsibility for the wrong in question and thus limit the liability of each wrongdoer.
Without an NCC, all the wrongdoers, liable for the same damage, are jointly and severally liable for the full amount of the claimant’s loss, regardless of the extent of their responsibility for that loss.
The Judge, at first instance, decided that the reference to "other consultants, contractors and specialists appointed by you" was ambiguous. At the time the NCC was entered into, it was understood that the Wests would themselves arrange for several aspects of the work to be done by a number of contractors outside the main contract with Armour, which IFA was expected to administer. The words could therefore be read as referring to those other contractors; and not Armour.
As there was a doubt about the meaning of the NCC, that doubt should be resolved in the Wests’ favour, given that the Unfair Terms in Consumer Contracts Regulations 1999 (the Regulations) provide that “if there is a doubt about the meaning of a written term, the interpretation which is most favourable to the consumer shall prevail.”
Accordingly, the Judge held that the NCC did not operate to limit IFA's liability to the Wests, where the other party liable was Armour.
That decision was overturned by the Court of Appeal, which decided that the normal meaning of the words in the NCC was crystal clear - namely that IFA's "liability for loss or damage" was to be limited to the amount that it was reasonable for it to pay having regard to "the contractual responsibilities of other consultants, contractors and specialists appointed by [the Wests]". There was no limitation on the words "other consultants, contractors and specialists appointed by [the Wests]" and, therefore, those words must be taken to mean any such persons, including any main contractor, but of course excepting IFA itself (because of the use of the word "other").
The meaning of a clause in a particular context is, of course, limited to the specific wording and surrounding facts. However, this is another example of the principle that the court should and will adopt the ordinary and natural meaning of the words in a contract when there is nothing in the factual background that is repugnant to that meaning.
Having found that the clause limited IFA’s liability, the Court of Appeal had to decide whether it was fair within the meaning of the Regulations and reasonable within the meaning of the Unfair Contract Terms Act 1977 (UCTA). If it was not, it would not be binding.
The Regulations were relevant, as the Wests were contracting as consumers. However, the court’s decision on the Regulations is also relevant to disputes between commercial entities as some of the factors the court has to consider under the Regulations are also relevant to the reasonableness test under UCTA.
An unfair term in a contract with a consumer is not binding on the consumer.
For unfairness to be established under the Regulations, the NCC would have to be both (a) contrary to the requirement of good faith and (b) cause a significant imbalance in the parties' rights and obligations to the detriment of the Wests.
Although the NCC clearly caused an imbalance in the parties' rights and obligations as it limited the Wests’ right to recover against IFA, the Court of Appeal did not consider that that imbalance was significant for the following reasons:
The Court of Appeal also bore in mind that the agreement between IFA and the Wests provided that IFA did not warrant the solvency of other contractors, that the Wests would appoint and pay other consultants and that the Wests should hold such contractors responsible for the competence and performance of their services.
The Court of Appeal decided that, even if it was wrong that the NCC did not cause a significant imbalance in the parties’ rights and obligations, the clause was not contrary to the requirements of good faith.
The Court of Appeal reached this decision despite its concern that the NCC contained "concealed pitfalls or traps": the NCC did not alert the reader to the fact that it limited IFA's liability to the amount that it might be ordered to pay on an apportionment of liability between parties jointly and severally liable. The Court thought that use of the word "reasonable" in the clause limiting IFA's liability "to the amount that it is reasonable for us to pay in relation to the contractual responsibilities" somewhat distracted the reader's attention away from that consequence.
The Court of Appeal was also concerned that the clause did not expressly draw the reader's attention to the fact that it shifted the insolvency risk of the other contractors from IFA to the client.
However, the judge at first instance had decided that the NCC was produced to the Wests fairly and openly and in reasonably large print on the third of three tailor-made pages of the Agreement. The judge decided that IFA was not guilty of any lack of good faith and was not out to take advantage of the Wests. The Court of Appeal was satisfied that IFA did not intend the NCC to be a concealed trap.
Further, the Court of Appeal had little doubt that the Wests were well able to understand the NCC and its ramifications, had they taken the time to do so, and so the 'pitfall' in the NCC was a matter of less importance than would otherwise have been the case. The wording and IFA’s failure to specifically draw the Wests' attention to the NCC and its effect were factors that weighed in the balance against the court deciding that the NCC satisfied the requirement of good faith. However, those factors alone were not enough to cause the NCC to fall foul of the Regulations.
The fact that the NCC was openly and fairly shown to the Wests and that the parties were of broadly equal bargaining power were factors in favour of a finding that the inclusion of the NCC satisfied the requirement of good faith.
Finally, looked at overall, the Court of Appeal regarded the NCC as fair under the Regulations as it was reasonable for IFA to be liable only for losses for which it can reasonably be held responsible, and for the Wests to take the risk of insolvency of the contractors they chose to appoint.
Taking all those factors together, the Court of Appeal decided that the NCC was not unfair.
Even though the Wests were contracting as consumers, UCTA was relevant as the contract was on IFA’s written standard terms. IFA, therefore, had to satisfy the court that the NCC was reasonable for it to be enforceable.
Having regard to the guidelines for determining reasonableness in UCTA, the Court of Appeal decided that the NCC was reasonable because:
The Court of Appeal decided that, where there is a valid NCC, the amount that it is reasonable for a wrongdoer to pay should be approached in the same way as an evaluation of contribution under section 2(1) of the Civil Liability (Contribution) Act 1978. The amount recoverable should therefore be the amount "found by the court to be just and equitable having regard to that person's responsibility for the damage in question". Such an exercise does not take into account the financial ability of the persons from whom contribution might theoretically be claimed to satisfy any claim against them.
The effect of the NCC was to limit IFA’s liability to the amount that it was reasonable for it to pay, having regard to "the contractual responsibilities of other consultants, contractors and specialists appointed by [the Wests]". The case was, therefore, remitted to the judge at first instance to evaluate the amount that it was reasonable for IFA to pay for the loss suffered by the Wests, having regard to their and Armour’s responsibility for that loss.
The decision seems very sensible and should apply to all NCCs, including where businesses are concerned. It is difficult to argue that a defendant should be liable for matters which are the responsibility of others. The judgment certainly makes it clear that NCCs are not unreasonable and ineffective, simply because they seek to avoid the principle of joint and several liability.
The fact that the NCC was, in a consumer context, found fair under the Regulations and reasonable under UCTA makes it very likely that a NCC clause will be found reasonable- and hence binding- under UCTA in a commercial context.
The Court of Appeal suggested that it would have been good practice for IFA to draw the Wests' attention to the NCC and its effect. That may still be relevant in a commercial context, as there can then be no argument that the claimant knew of the existence of the NCC. However, even that is unlikely to be relevant where the claimant was receiving legal advice when it entered into the contract.
A NCC can reduce a party’s liability in the event of it being jointly and severally liable with another contractor by limiting its liability to what it is reasonably responsible for. It also shifts the risk of a contractor’s insolvency onto the customer. Suppliers should, therefore, consider including NCCs in their contracts where they are involved in a project on which other contractors are engaged, linked with, as in this case, a clause limiting their liability to a specific sum. Such clauses should be clear and easy to understand.
Buyers faced with an NCC should give careful consideration to the financial position of all the contractors involved and their insurance position and, if appropriate and possible, should obtain a performance bond from the contractors.
This article was published in Commercial Litigation Journal in June 2014.