Excluding liability for dishonest breach: be careful what you wish for

Insight

11.03.2024

In this article, Ethan Ezra and Jane Randell discuss the recent Innovate Pharmaceuticals Ltd v University of Portsmouth judgment. In the case an exclusion and limitation of liability clause was found to be effective against a claim for dishonest breach of contract. Here, we ask whether parties should be more circumspect in agreeing to wide but fairly standard limits and exclusions of liability clauses.

The background

Innovate Pharmaceuticals Ltd (Innovate) is a medical research company who held the patent for a unique formula for liquid aspirin known as Glioprin which they were seeking to commercialise. In 2015, Innovate partnered up with the University of Portsmouth (UoP) in order to test the effects of their drug on a specific type of brain tumour. The parties entered into a research agreement in July 2016.

Key provisions in the agreement included:

Clause 11.4, which stated that UoP would: “not be liable for any…representation (unless fraudulent), or any warranty (express or implied) … for: any loss of profits, business, contracts, opportunity, goodwill, revenues, anticipated savings, expenses, costs or other similar loss; and/or any indirect, special or consequential damages or losses (whether for loss of profits or otherwise)”.
Clause 11.5, which capped each party’s liability to the other at £1m (excluding for death, personal injury, or fraudulent misrepresentation).
Clause 11.1, which required UoP to exercise all reasonable skill and care in carrying out their research, and clause 18, which required each party to “uphold the highest standard of business ethics”.

Dr Richard Hill, a senior academic within UoP’s brain tumour research centre, was chosen as the principal investigator to lead the project.

Shortly after signing the contract, the parties started the encounter issues, and Innovate grew frustrated with the project’s progress. Innovate also asserted that Dr Hill had made false representations as to the effects of the drug in August 2018. Most importantly, Dr Hill published a paper in the prestigious medical journal Cancer Letters regarding the research which had been undertaken on Glioprin. The paper was not well received and was roundly attacked for the accuracy of the data and figures it presented. Dr Hill was forced to publish a subsequent correction and apology for his work. Even this was not enough, however, as the journal eventually retracted the paper, and UoP found Dr Hill guilty of research misconduct too.

Innovate claimed that Dr Hill had deliberately (and fraudulently) manipulated the raw data from the study and sued UoP for:

The cost of redoing the research (around £1.4 million), and
The loss in value of the patent as a result of Dr Hill’s error-strewn research (around £94 million).

UoP defended this claim, saying the provisions of clauses 11.4 and 11.5 should be interpreted as meaning that its liability excluded loss of profits howsoever caused (including by dishonest breach) and was in any case limited to £1 million.

The judgment

The substantive judgment opened with an interpretation of clause 11.4 of the contract as an exclusion of all liability for loss of profits (which corresponded with limb (ii) of Innovate’s claim), unless the loss was caused by fraudulent misrepresentation, death, or personal injury.

In their submissions, Innovate had argued that UoP acted dishonestly in their performance (and by extension breach) of the contract and that, based on a well-known principle of contract law, they should not be able to exclude or limit their liability for fraud or deliberate wrong-doing.

However, the judge sided with UoP’s assertion that fraudulent misrepresentation was the sole excluded category of fraud here. It was not applicable in this case because Dr Hill’s work, although shoddy, did not amount to a ‘representation’ which had induced Innovate into signing the contract in the first place. Such a claim would correspond with the tort of deceit, which Innovate were not pursuing. Ter Haar J explained this as follows:

“A contracting party cannot exclude liability for its own fraud in inducing a contract. As to whether a clause excludes liability for fraud in performance of a valid contract is a matter of construction of the commercial provisions and risk allocation.”

Quoting an earlier judgment, he explains his reasoning as such: “Parties do not contemplate fraud in the making of a contract … there would be no deal. But it is another thing altogether to say that parties do not contemplate the risk of deliberate wrongdoing at some point in the performance of a valid contract. That is a matter for construction of the contractual provisions and risk allocation, whether by way of insurance or otherwise.”

Some might find this statement surprising, and the split between fraud inducing a contract and during its term a subtle one, but the authorities do appear to back this up.

The judge was clear that this was the case even though the agreement had a clause that included an express commitment to business ethics. This too was caught by the exclusions/limitations of clauses 11.4 and 11.5. The judge therefore concluded that it “adds little” to Innovate’s argument.

The judge analysed the clauses from an Unfair Contracts Terms Act 1977 perspective. But this was also given short shrift: there was no inequality of bargaining power and the contract had been actively negotiated. On the issue of whether the clauses were reasonable, the judge held that they were, particularly due to neither being blanket exclusions of all liability and the fact that UoP had been paid a relatively modest sum of £50,000 for this work. The judge suggested this could in itself underline the commercial necessity of these clauses: it is reasonable when a party stands to gain only a limited amount under a contract that it may seek to limit its exposure to losses of an order of broadly the same magnitude.

Having ruled on the underlying reasonableness and legitimacy of the limitation clauses, Ter Haar then considered UoP’s actual liability and concluded that they were indeed in breach of clause 11.1 of the contract in that they failed to use reasonable skill and care to ensure the accuracy of their work. Whilst the judgment noted the sheer number of errors in his work and the failure to adequately explain many of these mistakes, Dr Hill was not found to have acted dishonestly.

Overall, whilst UoP were therefore in breach of contract, the operation of clauses 11.4 and 11.5 meant that Innovate’s claim for loss of profits failed completely, and their claim for the costs of re-running the work, although successful, was capped at £1m.

Practice points

UoP will undoubtedly feel relieved at an outcome which was determined on an extremely fine reading of their contract with Innovate.

Whilst the judgment, and in particular its decision on limits for fraudulent misrepresentation versus fraudulent performance, were based on sound earlier case law, the result will likely be a surprising jolt for many practitioners. It remains to be seen whether the judgment will be subject to approving treatment in the future, but for the time being there are a few key practical points to bear in mind:

Careful fraud wording: this judgment makes clear there is no automatic guarantee that wilful wrongdoing/dishonest behaviour/fraud carried out during the contract itself will be caught by your limitation of liability clause. The case law cited in the judgment suggests that this has historically applied in cases where the dishonest actor is an agent/employee, rather than the defendant themselves, although this position makes less sense where the defendant is a corporate body and so always works through their employees. In all cases as a minimum though, and where the parties wish to be able to recover for losses arising from deliberate wrongdoing, the safe position would be to include contractual wording which mentions “fraud”, “dishonest breach” (or similar) as well as “fraudulent misrepresentation” as an express exception to a limitation/exclusion of liability.
Elaborate express clauses requiring a high standard of behaviour may be of little value: grandstanding clauses dealing with high standards of conduct business ethics (eg clause 18 in this case) may look good but will have limited impact when up against a well-drafted limitation of liability clause. The point to consider is how these types of clauses will interact and what carve outs you can negotiate from the liability limitation/cap. If a party is expressly committing to a high standard of behaviour, it would seem particularly pertinent to ensure that such failures can result in a meaningful recovery for losses arising.
Liability caps rooted in the commercial reality: despite what might be seen as an astonishing escape in this case, UoP was still ordered to pay £1m against a contract price of only £50,000 (with the cost of research being £80,000). While the actions of Dr Hill were so significant it can lead one to question the value of the contractual protection offered to Innovate, it is important to remember that this did appear to be an appropriate limit to agree to at the time the contract was formed. This reminds us that the more based on the commercial reality between the parties a liability clause is, the more likely it will withstand challenge.

This publication is a general summary of the law as at the date of publication. It should not replace legal advice tailored to your specific circumstances.