Limitation of liability and indemnity clauses: the knock-out punch of proportionate liability

In many cases limitation of liability clauses and indemnity clauses have effectively limited the risk borne by parties to a contract. But beware: the effectiveness of these clauses may be significantly impacted by the recent Australia-wide reform of apportionment of liability (the "Proportionate Liability Scheme").

Using a practical example, this article considers the real and daunting question of whether the Proportionate Liability Scheme has delivered a knock-out punch to limitation of liability and indemnity clauses in the various Australian jurisdictions.

Limitation of liability and indemnity clauses are traditionally included in contracts to manage the risk borne by a party for loss and damage that arises as a result of the performance of that contract. For example, if a distributor contracted with a manufacturer for the distribution of the manufacturer's product, it might be expected that the parties have negotiated limitation of liability and indemnity clauses. The limitation of liability clause will generally limit the distributor's liability for loss and damage arising out of the distribution of the manufacturer's product. The indemnity clause will generally give the distributor the right to be indemnified by the manufacturer for any liability arising as a result of the performance of its services pursuant to the contract.

The practical scenario

The distributor may want to rely upon its limitation of liability and indemnity clauses in one of the following four scenarios:

Scenario 1: the manufacturer sues the distributor for loss arising as a result of distributor's performance of the contract

Scenario 2: the distributor is sued by a third party for loss arising as a result of the distributor's performance of the contract

Scenario 3: the manufacturer is sued by a third party for loss arising as a result of the distributor's performance of the contract; and

Scenario 4: each of the manufacturer and the distributor are sued as concurrent wrongdoers as a result of distributor's performance of the contract.

Relevant considerations

In considering whether the Proportionate Liability Scheme will impact on the distributor's ability to rely on its limitation of liability and indemnity clauses in each of the above scenarios, it is important to remind ourselves of the types of claims which fall within the scheme. While the scheme differs slightly between jurisdictions in Australia, generally proportionate liability applies to situations where two or more people/entities have, by their simultaneous but independent wrongful acts or omissions, caused a single instance of economic loss or damage to property (that is, not personal injury) which arises in the circumstances listed in the relevant legislation (for example damage arising as a result of a failure to take reasonable care)[1].

The impact of the Proportionate Liability Scheme on the distributor's ability to rely on its limitation of liability and indemnity clause will differ between jurisdictions and hinges on two aspects of the Proportionate Liability Scheme, namely whether:

• contracting out of the Proportionate Liability Scheme is permitted; and
• a defendant against whom judgment is given as a concurrent wrongdoer in relation to an apportionable claim can be required to contribute to the damages recovered or recoverable from another concurrent wrongdoer in the same proceedings and/or indemnify any such wrongdoer.

Which jurisdictions permit contracting out?

Different jurisdictions have different approaches to contracting out of the scheme. New South Wales[2][3], Tasmania and Western Australia expressly allow contracting out of proportionate liability).

Conversely, the Queensland scheme expressly prohibits contracting out of proportionate liability[4].

The South Australian, Northern Territory, Australian Capital Territory, Victorian and Commonwealth schemes are silent as to whether or not contracting out is permitted. However, as a matter of construction, it seems that contracting out of proportionate liability is not possible in Victoria[5].

Where are concurrent wrongdoers not required to contribute or indemnify?

All jurisdictions contain provisions within their proportionate liability statutes which state that a concurrent wrongdoer can not be required to contribute to any damages or contributions received from another concurrent wrongdoer in respect of an apportionable claim[6].

With the exception of South Australia, the proportionate liability legislation applicable in all states and territories also states that a concurrent wrongdoer can not be required to indemnify another concurrent wrongdoer in respect of an apportionable claim[7].

However, in Western Australia, the Northern Territory and Tasmania, contractual indemnities and limitations of liability have been expressly excluded from the operation of the above provision by the insertion of the following subsection in their legislation:[8]

"Subsection (1) does not affect any agreement by the defendant to contribute to the damages recoverable from, or to indemnify, another concurrent wrongdoer in the proceedings."

None of the other States' legislation nor that of the ACT contains an equivalent provision.

Scenario 1

Given that the distributor and the manufacturer are not "concurrent wrongdoers" in Scenario 1, the Proportionate Liability Scheme will not affect the distributor's ability to rely on the limitation of liability and indemnity clause in its contract in that scenario.

Scenarios 2 and 3

In respect of Scenarios 2 and 3, the Proportionate Liability Scheme will only be enlivened if the other party is joined to the proceedings so that in effect both the distributor and the manufacturer become concurrent wrongdoers (and therefore the scenario becomes akin to Scenario 4) [9]. The comments made in Scenario 4 may therefore apply to Scenarios 2 and 3.

Scenario 4

On a plain reading of the provisions in the respective proportionate liability statutes under which concurrent wrongdoers are not required to contribute and/or indemnify another concurrent wrongdoer in respect of an apportionable claim, it would appear that contractual indemnities and limitations of liability are no longer effective to the extent that they require a concurrent wrongdoer to bear more than the liability apportioned to it by the court.

This is not the case in Western Australia, Northern Territory and Tasmania due to the inclusion of the sub-clause which excludes contractual indemnities/limitations of liability from the operation of that provision.

In New South Wales an appropriately drafted contractual clause may avoid contractual indemnities and limitations of liability being ineffective - as New South Wales is, in addition to Western Australia and Tasmania, a jurisdiction in which contracting out of the Proportionate Liability Scheme is permitted.

In respect of the Queensland, South Australian, Australian Capital Territory, Victorian and Commonwealth schemes (being the schemes in which contracting out is expressly prohibited and those, other than the Northern Territory, in which it is unclear whether contracting out is permitted), this position is currently only able to be countered by academic argument. Commentators have suggested that to render contractual indemnities and limitations of liability ineffective is contrary to the policy behind the proportionate liability legislation[10], that it is "unlikely Parliament would have intended to so drastically affect a party's commercial bargain"[11] and have suggested alternative interpretations other than the literal in order to ensure the effectiveness of a bargained contractual indemnity or limitation of liability clause[12]. However, it is yet to be seen what approach the courts will take in interpreting these provisions.

Accordingly, if the relevant proportionate liability legislation in Scenario 4 was that of Queensland, Victoria, South Australia or the Commonwealth, it seems the Distributor would be unable to rely on its limitation of liability and indemnity clauses and thus potentially be exposed to significantly greater liability than it bargained for.

Conclusion

The Proportionate Liability Scheme is relatively new and therefore there is still a great deal of uncertainty as to how the courts will apply it. However, unless the courts interpret the provisions under the proportionate liability statutes which state that a concurrent wrongdoer cannot be required to contribute and/or indemnify another concurrent wrongdoer in respect of an apportionable claim commercially(rather than literally), it would appear that contractual indemnities and limitations of liability are no longer effective to the extent that they require a concurrent wrongdoer to bear more than the liability apportioned to it by the court.

Furthermore, it is important to be aware that the Proportionate Liability Scheme can limit the effectiveness of contractual indemnities and limitation of liability clauses in contracts entered into prior to the introduction of the scheme.

Until these matters are clarified by the judiciary or the legislature, parties need to be careful to consider these issues when drafting agreements, deciding on the governing law of a contract, and when litigating and/or settling disputes under the Proportionate Liability Scheme.

It might be worth considering obtaining advice on the state of your contractual armour following the introduction of the Proportionate Liability Scheme to avoid your contractual limitation and liability clauses being delivered a knock out punch.