Ministry of Defence widens contractors' rights to limit liability

The UK's Ministry of Defence (MOD) has changed its policy so that, as standard practice, its suppliers can now limit their liability in contracts with the ministry. The MOD says it has listened to industry and frames this as positive development for contractors, which to some degree is true. The ministry is, of course, not altruistic and one of the consequences of this new approach is likely to be a downward pressure on prices. In turn, this will affect how defence contractors prepare and negotiate prices and contract limitations with the MOD.

New commercial policy statement

Earlier this year, the MOD published its commercial policy statement, Limiting of a Contractor's Liability and Indemnities (the link requires access to the MOD's Commercial Toolkit via the Defence Gateway). The document is internal MOD guidance which, though non-binding, indicates a significant change to the MOD's default position and general approach to contractors' liability. The policy seeks to align the MOD's approach with central government policy and commercial business-to-business relationships in the defence industry.

Other than in large scale procurements, the MOD has historically pushed against contractors limiting their liability. Its DEFCON standard terms do not even include a limitation of liability clause. The MOD would often justify this with the argument that its own liability was also unlimited and that there was, therefore, a level playing field. However, the MOD's main contractual obligation is generally payment of the price, which is quantified and therefore limited in practice – and, in our view, the level playing field argument often rang a bit hollow.

Under the new policy, the default position is to include liability limitations in the vast majority of MOD contracts. And to demonstrate the scope of the change, unlimited contractor liability will now only be accepted where it is "[required] under law or cross government policy, or, there is a demonstrable value for money case [for this]".

A part-positive move

Many contractors will welcome the MOD's new approach as it enables them to manage risk in a more conventional way . The policy statement says that the change aims to reverse the "detrimental effect on the market [of the old approach] including potential contractors being unwilling to accept the resultant balance between risk and reward or being unable to identify any viable mitigation measures".

However, the MOD has not done this out of the goodness of its own heart. Scratch the surface of the new policy and it's clear that there are some potential upsides for the MOD, which largely go to the contract price. These upsides raise a number of factors that contractors need to bear in mind, including:

• The MOD can argue that a contractor's price should not build in any contingency to take account of the risk of unlimited liability.
• The risk assessment mechanism by which the MOD will assess and agree the liability limitation is skewed in its favour and may give the ministry information that previously would not have been shared.
• The MOD will be very unlikely to deviate from the model limitation clause set out in the policy.

Downward pressure on prices

At each stage of the limitation analysis and negotiation process, the policy directs MOD personnel to consider what will provide it with the most value for money. They will assess price proposals on the basis that a contractor no longer needs to build in a contingency to account for unlimited liability. The MOD's argument will likely be that the inclusion of a limitation removes excessive contractor risk.

Contractors will need to deal with this on a case-by-case basis. Identifying a commercial risk that is not protected by the limitation, but over which the contractor has no real control, will be one way to approach this issue.

Risk assessments and caps

It is now mandatory for the MOD to undertake a risk assessment "to understand the potential financial liability being allocated to the MOD [as a result of a limitation of liability benefiting the contractor]". The MOD will use this information to decide the contractor's monetary limit of liability for contractor personnel at government establishments, material breach, issued property, loss of or damage to articles, and all other residual risks not already covered.

The MOD is likely to see itself as the ultimate decider. As with all elements of a contract negotiation, contractors will need to prepare and be able to justify a compelling position in order to achieve the best risk allocation. A well thought out and clear analysis will stand contractors in good stead.

The risk assessment process is likely to involve fairly significant dialogue and input from the contractor in order that the MOD can understand the liability landscape and agree how risk will be apportioned. The policy also states that in certain circumstances contractors may be required to submit two tenders, one containing contractor liability protections and one not. Contractors will have to allow for the extra work and costs which this will involve as well as planning the tactics of the discussion itself.

Mandatory limitation clause wording

The policy statement all but mandates that MOD personnel use a pre-approved Limitation of Contractor's Liability Clause and dictates the clause's wording (see Annex A of the policy). An MOD officer requires approval from their legal team for any deviation from the specific wording of the specimen clause, and all deviations must be "in line with government policy".

This rigidity will inform how a contractor prepares for the limitation discussion. Where clause wording cannot be amended, the way in which the contractor explains how its proposed apportionment of risk for the particular project is appropriate will be crucial.

Osborne Clarke comment

There will be a period of adjustment. Many MOD commercial officers, due to the ministry's former policy, will not have previously needed to consider these issues in the way that is now required.

Contractors are, of course, very familiar with negotiating limitation of liability provisions. However, on many MOD procurements, contractors will have little or no scope to alter the liability-limitation wording. This in turn makes it essential to prepare the rationale and supporting information to facilitate the ministry's risk assessment in a way that will lead to a favourable risk apportionment.

Please reach out to your contact at Osborne Clarke if you would like any further advice.

Ellie Downey and Kristen Harris also contributed to writing this article.