Public Companies Update October 2004

3 EXCLUSION CLAUSES IN ENGAGEMENT LETTERS

Accountants who gave negligent advice about the implementation of a profit related pay scheme have recently been held liable for damages for their client's loss of anticipated tax savings and those damages were not excluded by a limitation of liability clause in their engagement letter.

3.1 Facts
PriceWaterhouseCoopers (PWC) were engaged by the University of Keele (Keele) in connection with establishing a profit related pay scheme (PRP Scheme). In order to be valid the PRP scheme had to be registered with the Inland Revenue and a number of conditions had to be satisfied. Keele failed to satisfy all of the conditions for a valid PRP scheme which the court found was due to PWC's error and accordingly Keele sought damages for professional negligence from PWC.

PWC's engagement letter included certain limitations on their liability including that:

Subject to a limitation of £1.7 million, PWC accepted responsibility to pay damages in respect of loss or damage suffered by Keele as a direct result of providing the services (the first limb).

All other liability was expressly excluded, in particular, consequential loss, failure to realise anticipated tax savings and failure to obtain registration of a PRP scheme (the second limb).

At first instance, it was the judge's view that the first limb and the second limb were contradictory and that the first limb should take precedence over the second limb. It was held that the loss of chance to obtain the anticipated tax savings under the PRP scheme was a direct result of PWC's negligence under the first limb and was not excluded by the second limb.

PWC's appeal against this decision was based upon the interpretation of the limitations of liability. Both parties agreed that there was no contradiction between the first limb and the second limb as the judge had held at first instance. They also agreed that the failure to realise an anticipated tax saving constituted loss falling within the first limb, although PWC argued that this would only be the case if a second limb were not present on the basis that the failure to realise anticipated tax savings was expressly mentioned in the second limb and therefore should be excluded.

PWC argued that the judge at first instance erroneously failed to find a meaning for the second limb and that a reasonable person would have realised that a failure to obtain anticipated tax benefits was excluded under the second limb. On the other hand Keele argued that the purpose of the first limb was to define the liability that was accepted and that the loss in a form of anticipated tax benefits fell within this limb as it was suffered as a direct result of PWC's provision of services. They argued that the purpose of the second limb was to exclude liability for losses other than those covered by the first limb.

The court was faced with the task of reconciling the first limb and the second limb in a situation where the loss arising from the failure to realise anticipated tax savings was covered by both limbs.

3.2 Court's Interpretation
In dismissing PWC's appeal, the Court of Appeal held that:

(i) The first limb and the second limb should be read as a whole and meaning should be given to both if that were possible.
(ii) The word "other" at the start of the second limb was crucial to the interpretation of the clause. It meant that the first limb took precedence over the second limb and had to be given an interpretation that enabled the liability that PWC accepted to take effect. The second limb covered loss not falling within the first limb and although it repeated categories of loss covered in the first limb, redundancy of contractual provisions did not mean that interpretation of those provisions had to be incorrect.
(iii) The first and second limbs were not self contradictory, but the judge at first instance had reached the correct conclusion. Keele had suffered the loss as a direct result of the provision of services which fell within the first limb and this was not qualified by the provisions contained in the second limb.

3.3 Conclusion
This case demonstrates the importance of precise wording when drafting or reviewing limitation clauses, particularly those in engagement letters of professionals. It is important to remember that to effectively exclude or limit liability to a client, either in contract or tort, an exclusion or limitation in an engagement letter must be clear since it will be construed against the advisor seeking to rely on it.

If you require further information on any matter covered in this note, please contact your principal contact at Charles Russell or Simon Gilbert, Katy Knight, Clive Hopewell or Alexander Keepin (London), Francis Rundall or Richard Norton (Cheltenham) or Catherine Drew or Geoff Sparks (Guildford) on 0207 203 5000.

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