Gross negligence interpreted and applied
15 Mar 2013
This article was published in the February edition of the International Financial Law Review.
In a decision helpful to both special purpose vehicles (SPVs) and service providers utilising SPVs, the Irish Supreme Court has given effect to a gross negligence carve-out to a general (and standard-form) limitation of liability clause (Clause) in an Irish-law commercial licence. The case also highlights the dangers of taking for granted the protections such clauses purport to provide, in particular where key terms such as gross negligence and wilful default are not defined.
In GCC Foundation FI-LLC v European Computer Driving Licence Foundation Ltd  IESC 55, a licensor sought to rely on the Clause to cap its liability in respect of a lower court finding that it had breached the licence. The Clause did not apply where there was gross negligence, but the term ‘gross negligence’ was not defined in the licence.
The Court had no difficulty giving effect to the Clause, but on the facts found that the licensor’s behaviour leading to the breach constituted gross negligence. Accordingly, the carve-out applied, and the licensor faced an uncapped liability exposure.
In applying the carve-out, the Court endorsed the lower court's approach which "assumed that the parties intended the clause to have meaning and, indeed, a meaning which would have business efficacy".
The Court found it significant that the parties had agreed to a standard of gross negligence as opposed to negligence only. It found that the appropriate meaning of 'gross negligence' (in the context of the Clause) to be 'a degree of negligence where whatever duty of care may be invovled has not been met by a significant margin'.
Applying this 'significant margin' test, it found that the carve-out would apply when alleged breach of contract could be said to have resulted from the conduct of the offending party which was, with regard to the party's obligations arising under the contract, significantly careless.
The case is helpful in that the Court recognised that undefined 'gross negligence' terminology in commercial contracts can and should be given effect to provide business efficacy to the agreed terms.
However, the standard of gross negligence endorsed appears to represent a significantly lower level of culpability than what is generally considered to be the best in the UK (that is, the obiter Hellespont Ardent standard), and the UK practitioners should be aware of this formal Irish departure from their position (for example, when dealing with Irish asset-holding or debt-issuing SPVs).
Secondly, the Court appeared to rely on failure to observe extra-contractual commercial good faith obligations in part as justifying its findings of gross negligence. Such an approach may obviously add to commercial uncertainty, rather than limit it.
UK practitioners may find the dissenting judgment to be more useful on these issues. The dissent cautioned against ascribing overly broad meanings to undefined carve-out terms, arguing that to do so would result in an inversion of the fundamental logic and purposes of limitation clauses. Such an interpretation would mean that the "exception almost swallows the general limitation".
The dissent also endorsed the Hellespont Ardent formulation of gross negligence, and further argued that the Court erred in appearing to ascribe obligations to the licensor beyond those expressly found in the licence itself, declaring that it is the "contract which defines the conduct which is expected from each party".
General limitation clauses (and indemnity provisions) and standard carve-outs are often lightly negotiated as largely-settled boilerplate provisions. Corporate service providers with no underlying economic interest in a structure often assume that they are protected from liability is precise.
Commercial and risk certainty can be achieved through a number of strategies. For example, explicitly and strictly limiting on's duty of care to the other party to expressly assumed obligations, introducing monetary caps for carve-outs in addition to those that apply generally, and most simply, by defining what is meant by gross negligence (and other carve-out terms).
The Irish Supreme Court decision is to be welcomed as confirmation from the final appellate court that sophisticated contractual parties should be free to limit liability for defective performance involving negligence.
Care should be taken to define the threshold standard of care that will results in no liability, however, as language that admits a range of meanings may not produce the intended result.
T: +353 1 619 2716