How to overcome a liability cap: a case study

Contracts for the supply of goods or services (including construction contracts) frequently contain provisions seeking to limit the quantum of liability for breach by the vendor or contractor. A liquidated damages clause is a familiar example of such a provision. Another is a clause that purports to limit liability to an amount equal to the cost of supply. In a recently concluded arbitration, Kennedys represented a client and its market of Reinsurers seeking to overcome such a provision, and were successful in doing so.

The facts

The claim arose as a result of a fire in key plant and equipment at a processing facility located in the Sultanate of Oman, owned and operated by the insured, the employer under an EPC contract (and claimant in the arbitration). The fire occurred whilst the contractor (respondent in the arbitration) was performing certain renovation work the subject of the EPC contract. This involved undoing various bolted connections on a process vessel. The unbolting was anticipated to be performed by the use of a torque wrench and manual tools or, as a last resort, using oxyacetylene cutting to remove bolts that were badly corroded.

Due to (it would seem) pressures of time, and delays and difficulties in removing a number of corroded bolts, the contractor ultimately decided (without applying for or obtaining a specific hot work permit), to use oxyacetylene cutting, not to remove the bolts, but instead, to cut through the vessel itself. In the course of doing so, globules of molten slag fell inside the vessel and ignited a bed of flammable material within it.

The fire caused extensive damage to the vessel, and as a consequence, all operations at the facility were suspended for several months pending the completion of rectification work, giving rise to substantial (physical damage and business interruption) losses being suffered by the employer. The reinsurers indemnified most of those losses and therefore had a significant interest in the claim against the contractor, pursued on a subrogated basis in the name of the employer (i.e. the insured). In the proceedings, the losses (both insured and uninsured) were quantified and claimed in a sum in excess of US$50 million. The contract price under the EPC contract was approximately US$15 million.

Relevant contract term

The EPC contract was governed by Omani law. It contained a term which provided in part that “The contractor’s liability under the contract shall never exceed the contract price”. The contractor sought to rely on that provision (amongst others) to argue that the maximum amount for which it could be liable could not exceed a sum equal to the contract price, namely US$15 million. That argument failed.

It was common ground between the parties that, in principle (subject to exceptions), Omani law recognises the validity of contractual provisions seeking to limit or exclude liability for breach of contract. The rationale for this principle is that the source of the limitation is consensual. By contrast, there are various provisions of Omani law that preclude a party from exempting or limiting its liability for ‘harmful acts’ (i.e. what may be termed liability in tort). In particular, Article 183 of the Oman Civil Code provides:

As an aside, the position is similar under UAE law where, in particular, Article 183 of the Oman Civil Code finds a direct counterpart in Article 296 of the UAE Civil Code.

The employer therefore argued that the contractor’s actions amounted to both breaches of contract and harmful acts, such that the contractor could not escape liability for the latter (unconfined by any contractual limitation), even if it could do so in relation to the former. The contractor argued that, under Omani law, contractual and tortious liability cannot arise jointly out of the same breach, and that a claim in tort is not permitted under Omani law in the context of a contractual relationship. As such, so the contractor argued, the employer’s entitlement, if any, was confined to a claim for breach of contract, and the employer was therefore stuck with the cost of supply limitation in the EPC contract.

Findings of the tribunal - gross fault

However, irrespective of the merits of that argument, it was also common ground between the parties that even a limitation of liability for breach of contract will be ineffective in the event that fraud or ‘gross fault’ (i.e. what may be termed gross negligence) can be established. In other words, a claim for breach of contract is treated in the same way as a tort claim in the event of gross fault. The employer therefore advanced an alternative claim on the basis of gross fault (fraud was not alleged). Did the circumstances amount to gross fault?

The crucial finding of the tribunal was that the contractor’s acts and omissions, taken together, were indeed sufficiently serious to constitute “a gross fault under Omani law”.

The parties’ respective Omani law experts disagreed over the standard to be applied in assessing gross fault. However, the tribunal found that this issue did not need to be decided, as the contractor’s conduct fulfilled the requirements of its own, higher standard, saying:

“The fire and the resulting material damage meet the requirement for the gravity of the damage. [The contractor’s] faults are multiple and are significant, in particular its failure to apply for a relevant permit for hot working, contrary to the EPC contract, HSE manual and industry practice. As to foreseeability of the occurrence of the damage, the [material] was known, or should have been known by [the contractor] to be flammable, so that it should have been obvious that oxyacetylene cutting above such material, without properly protecting it, was highly likely to cause a serious fire.”

On the strength of the fundamental finding of gross fault, the tribunal had no difficulty in rejecting (amongst others) the contractor’s argument based on the contractual cost of supply limitation:

It was common ground between the parties that Omani law permits the apportionment of losses where both parties are at fault. Whilst finding that the actions of the contractor were primarily responsible for causing the fire, the tribunal found that the employer was also in breach of its contractual duties to supervise the performance of the works (not amounting to gross fault), and this was reflected in a reduction in the award sum. The employer nevertheless secured a final award in a sum (including interest and costs) exceeding US$40 million. This was well in excess of the contract price of approximately US$15 million and represented a very favourable result, for reinsurers and the insured alike.

Conclusion

Limitation (or exclusion) of liability clauses can perform a useful function in providing a measure of certainty to contracting parties in relation to the allocation of risk. However, they can give rise to serious obstacles to what may, on the merits, be meritorious claims, in circumstances where unforeseen events cause sometimes significant losses. The laws of Oman (and the UAE) provide claimants with mechanisms to overcome the potentially unfair and unanticipated effects of such provisions in certain circumstances. The case discussed above provides an illustration. The findings were heavily fact-sensitive, but the following conclusions may be drawn (as a matter of both Omani and UAE law):

• A cost of supply (or any other contractual) limitation clause – freely entered into - may well be effective in relation to a claim for breach of contract.
• Such a clause will be of no effect in relation to a tort claim, though in the context of a contractual relationship it may be difficult for the claimant to establish an entitlement distinct from liability in contract.
• Even in a ‘pure’ contractual claim it may be possible to circumvent the effect of a cost of supply (or other contractual) limitation or exclusion clause if the breach can be demonstrated to meet the (high) test for gross fault.

Read other items in Construction and Engineering Brief - July 2021