UCT 101: The usual suspects #3 – liability and indemnity clauses 

Welcome to the sixth article in our ‘UCT 101’ series, designed to assist businesses in preparing for new reforms to the unfair contract terms (UCT) regime under the Australian Consumer Law (ACL)¹ introduced by the Treasury Laws Amendment (More Competition, Better Prices) Act 2022 (Act). The reforms to the UCT regime under the Act will take effect on and from 9 November 2023. From that time, civil pecuniary penalties, which have also increased significantly as part of the reforms, will apply for breaches of the UCT regime. See here for more information about the changes to penalties.

In the first three articles of our series, we discussed some of the preliminary foundational questions associated with the application of the unfair contract terms regime, namely – what constitutes a ‘standard form contract’, a ‘small business contract’, and an ‘unfair contract term’ for the purposes of the UCT regime. In the fourth and fifth article of our series, we turned to look at some of the ‘usual suspects’ when it comes to the UCT regime – that is, those terms that by their nature run a higher risk of being unfair.

In this article, we consider our third and final ‘usual suspect’ in the series – liability and indemnity clauses. We will discuss the circumstances in which these clauses can be unfair, and look at some of the case law which has examined these clauses under a UCT lens.

What makes a clause unfair?

We have discussed in previous articles in the series what kinds of contracts will be subject to the UCT regime. This is a core consideration in determining whether, from the outset, the UCT regime is even necessary to consider. Once this is established, there are three main limbs that are used to determine whether a term of a standard form consumer or small business contract is unfair under the ACL (UCT Test).² These limbs are set out below, and if all of them are satisfied, the term will most likely be unfair.

Limb 1: The term causes a significant imbalance in the parties’ rights and obligations arising under the contract.
Limb 2: The term is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term.
Limb 3: The term would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.

In applying the UCT Test, a court may take into account such matters as it thinks relevant, but must take into account the extent to which the term is transparent, and the contract as a whole.³

What is a limitation of liability clause?

Limitation of liability clauses are used by parties to a contract to limit the liability of one or more parties for loss arising under or in connection with the contract. These clauses are used in a wide range of commercial agreements, such as sale and purchase agreements, licencing agreements and terms and conditions.

There are various ways to structure a limitation of liability clause in a contract, for example, this might look like the imposition of an overall cap on liability, an exclusion of liability for consequential loss, or an exclusion of liability altogether. The following are some common types of limitation of liability clauses:

Example 1: “The parties exclude liability for any consequential or indirect loss arising under or in connection with this agreement” 

Example 2: “The supplier limits its liability in respect of the goods to: (a) the replacement of the goods or the supply of equivalent goods; (b) the repair of the goods; (c) the payment of the cost of replacing the goods or of acquiring equivalent goods; or (d) the payment of the cost of having the goods repaired”.⁴

Example 3: “The liability of [Party A] under and in connection with this agreement will not exceed the higher of: (a) the total amount paid or payable by [Party B] under this agreement; and (b) $[1 million].” 

Example 4: “[Party A] excludes liability for all loss, liability, damage or claims, howsoever incurred under or in connection with this agreement.”

When is a limitation of liability clause unfair?

The only sure-fire answer to this question is that a limitation of liability clause will be unfair where it is determined as such in accordance with the UCT Test. Whether this is the case will largely depend on the facts of the arrangement, and the specific terms and conditions of the relevant contract.

There may be some guidance to be found under section 25 of the ACL, which sets out a range of clauses (known as the ‘grey list’) that may be unfair if used in a consumer or small business contract. This includes a term that limits, or has the effect of limiting, one party from suing the other.⁵

Additionally, guidance can be found from the ACCC’s previous actions against businesses for alleged UCT, which have served to highlight two main ‘categories’ of UCT that may arise from limitation of liability clauses. These are:

• Category 1: limitation of liability clauses which are one-sided in that they limit the liability of one party but do not provide a corresponding right or limitation to the other party (such as examples 2, 3 and 4 above); and
• Category 2: limitation of liability clauses that are so broad that that they effectively exclude a party’s liability altogether (such as example 4 above).

The actions taken by the ACCC have tended to focus broadly on the categories set out above, and have not provided any specific guidance on whether certain elements of a limitation of liability clause (such as an overall liability cap or exclusion of certain types of loss) are intrinsically unfair in and of themselves. Rather, these elements are, at least for now, dealt with as part of the overall consideration of the UCT Test and often in the context of the two categories listed above.

With that in mind, let’s take a look at some of the ACCC actions and investigations that have dealt with limitation of liability clauses, which broadly relate to the categories set out above:

• In ACCC v Servcorp Limited [2018] FCA 1044 (Servcorp), clauses used by Servcorp that purported to limit Servcorp’s liability under its customer contracts were found to be unfair, in circumstances where Servcorp’s liability in relation to certain losses was limited (except only in the case of gross negligence or wilful misconduct), and the customer had no corresponding limitation of liability to rely on.⁶ This limitation of liability arose in relation to an indemnity in the customer contracts, which is further discussed below.
• In ACCC v JJ Richards & Sons Pty Ltd [2017] FCA 1224 (JJ Richards), clauses used by JJ Richards that purported to limit JJ Richard’s liability under its customer contracts were found to be unfair in circumstances where JJ Richard’s overall liability was excluded to the maximum extent permitted by law, and the customer had no corresponding benefit.⁷ This limitation of liability arose under an indemnity in the customer contracts, which is further discussed below.
• In ACCC v Fujifilm Business Innovation Australia Pty Ltd [2022] FCA 928 (Fujifilm), the following clauses used by Fujifilm that purported to limit its liability under its customer contracts were found to be unfair:
  • clauses that only required Fujifilm to use reasonable endeavours to deliver the goods under the contract and provided that Fujifilm was not liable, to the extent permitted by law, for any delay (in which case the customer did not have any right to be excused from the charges payable); and
  • clauses that imposed significant caps, reductions or limitations on Fujifilm’s total liability (in circumstances where the customer was required to pay termination payments without any such reduction, cap or limitation).
• In response to an ACCC investigation, gaming services provider Maxgaming Qld Pty Ltd (Maxgaming) provided a court-enforceable undertaking to amend potentially unfair contract terms in its customer contracts, including a term that excluded Maxgaming’s liability with no corresponding benefit to the customer.

What about clauses that exclude liability for consequential loss? Are they unfair?

As noted above, Australian Courts have not expressly considered, and the ACCC have not published any guidance in relation to, whether excluding consequential loss, as a general concept, is likely to be inherently unfair. There may well be circumstances in which a party could show, per the UCT Test, that excluding consequential loss was ‘reasonably necessary’ to protect its ‘legitimate interests’. For example, a party might be able to demonstrate that it was reasonably necessary to exclude consequential loss, given that loss of this nature cannot always be determined or insured against, and the risk of unlimited liability for consequential loss would thus make the contract unviable.

But what about contracts where the consequential loss is the only loss that could be expected to arise from a breach of contract or negligence, such as in a confidentiality agreement? In a confidentiality agreement, a disclosing party may divulge confidential information about their trade secrets to a recipient, which if misused by the recipient, could lead to the disclosing party suffering a loss of profits. If the confidentiality agreement contains a consequential loss exclusion, and the definition of consequential loss includes loss of profits, this is likely to deprive the disclosing party of the right to recover the losses that it is likely to incur as a result of the recipient’s breach of contract or negligence. In such case, the limitation of liability clause would effectively result in the exclusion of all relevant types of loss, which the ACCC has noted may be unfair (ie because it falls within Category 2 above). In situations where this type of agreement related to the supply of goods or services, and otherwise met the application requirements of the UCT regime, there is potential for a consequential loss exclusion to be considered unfair, as the party relying on the exclusion clause may not be able to demonstrate that the exclusion of consequential loss is reasonably necessary to protect its legitimate interests.

What is an indemnity clause?

Indemnity clauses are used in contracts to place an obligation on one party (indemnifying party) to compensate the loss of another party (indemnified party), generally due to the actions of the indemnifying party or its representatives. Like a limitation of liability clause, an indemnity clause can take effect in various forms, for example relating to all loss suffered by the indemnified party under a contract, or only specific types of loss. The following are some common types of indemnity clauses:

Example 1: “Each party (indemnifying party) indemnifies the other party (indemnified party) against any loss which the indemnified party suffers, incurs or is liable for in connection with a breach of this agreement by the indemnifying party, except to the extent the loss is caused by the indemnified party.” 

Example 2: “The seller indemnifies the buyer and agrees to hold the buyer harmless against any loss suffered or incurred by, or any claim made against, the buyer arising in connection with any breach of warranty by the seller.”

Example 3: “[Party A] agrees to provide the materials to [Party B] to allow [Party B] to perform the services, and indemnifies [Party B] and each of [Party B]’s representatives from and against any claims made against, or loss incurred by, any of those indemnified where such claim or loss arises out of any infringement of the intellectual property rights of a third party arising from [Party B]’s use of the materials under this agreement.” 

When is an indemnity clause unfair?

As with limitation of liability clauses, this question ultimately comes down to the application of the UCT Test. There is however guidance to be found from the ACCC’s previous actions against businesses for alleged UCT, which, like with limitation of liability clauses, have served to highlight two main ‘categories’ of UCT that may arise from indemnity clauses. These are:

• Category A: indemnity clauses which are one-sided in that they limit the liability of one party but do not provide a corresponding right or limitation to the other party; and
• Category B: indemnity clauses which require the indemnifying party (Party A) to be responsible for compensating the indemnified party (Party B) for something that was actually caused or contributed to by Party B.

Contracting parties will often seek to address the issue in Category B by including a ‘carve out’ to the indemnity clause, such as:

“This indemnity will not apply to the extent that the relevant loss was caused by the indemnified party [Party B]”. 

However, UCT issues can still arise where the carve out used to address the issue in Category B does not go far enough to remedy the issue, for example:

”This indemnity will not apply to the extent that the relevant loss was caused by the gross negligence of the indemnified party [Party B]“.

The effect of this type of drafting is that, if Party B caused or contributed to the loss, but had only been “negligent” in doing so, rather than “grossly negligent”, Party A would still have to indemnify Party B. The same would apply if Party B had caused or contributed to the loss in any other manner, including by breach of contract, breach of law, or other act or omission (to the extent those actions would not amount to gross negligence).

These issues, as well as those more broadly relating to Category A and Category B above, have previously been considered in a judicial context, with some key decisions set out below:

• In Servcorp, an unlimited indemnity included by Servcorp in its customer contracts was found to be unfair in circumstances where the customer was required to indemnify Servcorp for certain kinds of loss, even where the loss or damage was caused by Servcorp (subject only to any gross negligence or wilful misconduct), and where the customer had no corresponding benefit in its favour.⁸ This point was closely related to Servcorp’s limitation of liability clause which is discussed above.
• In JJ Richards, an unlimited indemnity included by JJ Richards in its customer contracts was found to be unfair in circumstances where the customer was required to indemnify JJ Richards for any loss or liability arising in connection with the contract, even where the loss incurred by JJ Richards was not the customer’s fault or could have been avoided or mitigated by JJ Richards, and where the customer had no corresponding benefit in its favour.⁹
• In Fujifilm, the following indemnity clauses used by Fujifilm in its customer contracts were found to be unfair:
  • clauses that required the customer to pay Fujifilm for all costs and expenses incurred in exercising its contractual rights on a full indemnity basis, without any corresponding right for the customer; and
  • clauses that required the customer to indemnify Fujifilm for loss or damage to the goods supplied under the contract (including all associated costs), with the only exclusions being normal wear and tear, and any loss or damage attributable to Fujifilm’s negligence or default. It was acknowledged in the parties’ joint submissions that this would require the customer to indemnify Fujifilm for damage caused by third parties, or accidentally or indirectly by Fujifilm.¹⁰
• In response to an ACCC investigation, Maxgaming provided a court-enforceable undertaking to amend a term in its customer contracts that created a broad indemnity in Maxgaming’s favour, including for liability due to Maxgaming’s negligence or wilful default, with no corresponding benefit to the customer.

Ok, so how do I make my limitation of liability clause or indemnity clause fair?

While this will depend on the type of contract and the arrangement between the parties, our top tips are as follows:

1. Do you need an indemnity? Consider whether UCT risk can be managed by removing the clause altogether and having the parties rely on their common law rights.
2. Can you live with a mutual liability or indemnity clause? If you are including a limitation of liability or indemnity clause, consider whether UCT risk can be managed by making the clause mutual, or by limiting its application to specific kinds of loss referable to the contract. Note however that a one-sided indemnity may be warranted in some circumstances, for example a licensor indemnifying a licensee from any breach of the licensor’s warranty that it owns the IP in the rights it is granting to the licensee.
3. Ensure your liability and indemnity clauses are not too broad. Per the cases listed above, the ACCC regards limitation of liability and indemnity clauses that are too broad as unfair. In most cases, a balanced and reasonable limitation of liability or indemnity clause would adequately protect a party without creating UCT risk.
4. Provide adequate carve outs to a liability and indemnity clause. Generally speaking, a limitation of liability or indemnity clause included in a contract should only go so far as reasonably necessary to protect the party relying on the clause, and should be reduced to the extent that the party relying on the clause caused or contributed to the relevant loss. Overly restrictive carve outs could be problematic, such as carve outs that only reduce the liability of the party relying on the clause for specific actions like the party’s “gross negligence”. These types of restrictive carve outs have been regarded as unfair by Australian Courts.

Next edition

This article concludes our core ‘UCT 101’ series. Stay tuned for future instalments of the series as the effective date for the new regime gets closer, and we begin to consider some of the interesting points and practical issues presented by the new regime, such as its application to different contracting models.

How can we help?

We have a dedicated contracting and consumer law team that can assist you with contract preparation and review and can provide you with advice on your rights and obligations under the ACL, particularly in light of recent reforms. We also routinely present to businesses on the Australian Consumer Law and the unfair contract terms regime. Please contact us if you would like more information about the services we provide.

This article was written by Teresa Torcasio, Partner and Zoe Vise, Associate.

¹Competition and Consumer Act 2001 (Cth), Schedule 2 ‘Australian Consumer Law’ or ‘ACL’.
²ACL, s 24.
³ACL, s 24.
⁴This is an example of a limitation of liability clause structured in accordance with clause 64A of the ACL.
⁵ACL, s 25(k).
⁶Servcorp at [53] – [54].
⁷JJ Richards at [56(g)].
⁸Servcorp at [53] – [54].
⁹JJ Richards at [56(g)].
¹⁰Fujifilm at [6(8)].