Nick Sarker is an Associate in theIP/IT Group of Clarks Solicitors based in Reading. He can be contacted at nicksarker@larks-solicitors.co.uk
Over the past few months there has been a great deal of publicity concerningcomputer projects which have gone badly wrong, particularly in the publicsector, but for those of us who work on software disputes it is comparativelyrare for us to be treated to case reports on the subject. While we have yet tosee whether in years to come litigation will ensue in relation to the recentfiascos at the Passport and Benefit Agencies, the recent case of South WestWater v International Computers Limited provides plenty of interestingreading for the time being.
The South West Water case confirms some key aspects of the St Albans’decisions (see St Albans City Council v International Computers Limited[1996] 4 All ER 481) and also provides a commentary on how the law ofrestitution can be applied to computer projects. Given the harrowing catalogueof problems on the project in issue, and the criticism levelled at theenforceability of its standard terms in St Albans, ICL has recently beenstung badly, not once but twice, in the courts. On a practical level South WestWater also appears not to have learnt from its mistakes. The computer projectwas South West Water’s second attempt at implementing a customer informationsystem. Its first supplier (DIGITAL) failed to deliver a working system and theproject was re-tendered and eventually awarded to ICL; of course, ICLsubsequently failed.
Apart from its factual and contractual implications, the present case alsoprovides some interesting procedural threads. It is apparent that the partiesspent a great deal of time and money on detailed expert witness evidence for thecase (on liability), practically none of which was used at the actual hearing.One would imagine that the parties’ costs, coupled with the huge amount ofmanagerial time that must have been spent by the parties in proofing theirwitnesses and on the disclosure of documents, would be equivalent to asubstantial proportion of the amounts actually in issue in the proceedings.
A Doomed Start
South West Water, like all utilities in the UK, is subject to controls andtargets set by its regulator. In 1994 OFWAT indicated that it would cap theincreases South West Water could make to its charges over the next 10 years. Inorder to maintain its profitability South West Water started to take steps toreduce its operating costs, and saw the improvement of its customer service ITsystems as an integral step. Improvements in a system which dealt withresponding to billing contacts, replying to written complaints and issuing billswould provide a means of cutting back on employees, thereby improvingefficiency. This economic rationale for the new customer information system willno doubt be referred to in great detail when damages are assessed on the case(only the trial on liability and South West Water’s interim award of damageshave been reported so far).
As already mentioned, South West Water originally awarded the contract forthe system to DIGITAL, but they were unable to deliver a working system – andSouth West Water received a refund of the relevant sums it had expended. SouthWest Water developed a (revised) User Requirement Specification (URS) when theproject was re-tendered. ICL considered the URS and bid for the project on thebasis of modifications to the Custima package, which its subsidiary (CCSL) haddeveloped as a general billing package for the water industry. However, billingwas only part of what South West Water wanted its new system to do.
There is a great deal of discussion in the case about ICL’s estimate of thedegree of fit between Custima and the URS, and the number of man days requiredon bespoke development to complete the fit. As is often the case in computerprojects that fail from the outset, there appears to have been a wide divergencebetween what the commercial negotiators convinced themselves of in relation tothe amount of bespoke development needed, and the unheeded warnings given bytechnical people, including CCSL, as to the true amount of resource that wasrequired. In a highly competitive industry where software suppliers often seekto achieve exponential growth and sales people are conscious of their salesbonuses for new orders, it is comparatively easy for this to happen, althoughthis tendency is usually checked by internal company risk analyses (whichobviously were not effective in this case). Documentation from ICL reveals thatit deliberately underestimated the bespoke effort in the hope that South WestWater would drop various requirements once the project had started, and that,after South West Water ferociously bargained ICL’s price down, the project hadbecome a ‘loss leader’ for ICL by the time it entered into the contracts.
From Bad to Worse
The list of mistakes continues like an anti-methodology. ICL did not enterinto a back-to-back contract with CCSL (passing on various necessary contractualobligations), even though South West Water insisted that such an arrangement beset in place. CCSL even informed ICL before the contracts were signed that itwould not be able substantively to start working on the project for severalmonths, therefore putting into immediate doubt the absolute completion datewhich South West Water needed for its annual billing cycle.
The primary contract which ICL entered into with South West Water was in theform of a turnkey contract (ie ICL was supposed to deliver a ready-to-go systemto South West Water which could simply be switched on, as with the turn of akey). This was clearly inappropriate to a project which required a great deal ofbespoke work and co-operation from South West Water. A software developmentcontract would have been more appropriate and, as we shall see, ICL paid dearbecause of this choice. ICL also committed to delivering the system to a fixedprice and to a deadline of 31 October 1995 (although this was later extended),even though the project had a large, inaccurately quantified bespoke element.ICL was still investigating alternative technical solutions for the system inorder to try to reduce the bespoke element two months before signing thecontract. There is even an express statement in the turnkey contract that ICLrecognised that the scope of work was demanding, but that it was responsible formanaging the risk. In addition to the turnkey contract, there was a separateproject management agreement between ICL and South West Water.
Although the list of ICL’s mistakes is long, South West Water could havebeen more alive to what it was getting itself into. His Honour Judge Toulmin CMGQC, who presided over the case in the Technology & Construction Court,declined from apportioning any blame against the utility, but South West Waterfailed to heed its own internal warnings and forced the price down to such anextent as to make the project not worthwhile for any supplier as hapless as ICLto enter into. At the end of the day South West Water wanted a working systemthat met its needs, not just ammunition with which to sue an incompetentsupplier.
The project took its predictable course. The underestimate of the ICL-CCSLresource effort immediately came to light and early on ICL realised that itcould not meet the original contractual deadline. However it refrained fromcoming clean with its customer until comparatively late. CCSL co-operated evermore reluctantly on a project which sucked resources into a black hole. ICL’sproject managers changed, indicating poor morale on a loss-making project whichits staff did not want to work on. Crisis audits were conducted to find a wayforward and possible alternative technical solutions. Attempts were made towater down the scope of the system to what ICL could deliver rather than whatSouth West Water wanted and bitter recriminations appeared in internal documentsfrom both sides. Needless to say the system was not delivered by 31 October 1995and, when ICL finally indicated that it could not meet revised completion datesfor the next annual billing cycle, South West Water finally lost patience, andin March 1996 terminated the contracts. The court held that South West Water wasentitled to do this as ICL’s indication that it could not meet thecontractually agreed deadline for completion amounted to repudiatory breach.
Misrepresentation
The court had no difficulty in finding that South West Water had anactionable claim in misrepresentation against ICL by reason of its statementsthat it would enter into a back-to-back agreement with CCSL, knowing that thiswas unlikely to happen. In the turnkey contract there was a general entireagreement clause excluding, among other things, any pre-contractualrepresentations or warranties. The decision in Thomas Witter v TBP Industries[1996] was upheld and the entire agreement clause failed the Unfair ContractTerms Act 1977 (‘UCTA’) reasonableness test because, by its general nature,it purported to exclude liability for fraudulent misrepresentation (I willassume for the purposes of this article that readers are familiar with theprinciples of UCTA, and indeed extensive articles have been written about itsoperations in previous issues of this journal, such as Harry Small’s articlein Feb/March 1999 issue). South West Water could therefore claim for damagesflowing from the misrepresentation.
Limitation of Liability
ICL sought to rely on various clauses in the contracts to limit itsliability, the turnkey and project management contracts containing identicalclauses on the issue. Where South West Water was legally entitled to reject thesystem in question, ICL would have to return all monies paid by South WestWater. In all other cases (except in the usual cases of death and personalinjury, liability for which was unlimited, and damage to property limited at £1million), ICL’s liability was limited to £250,000. The trial judge noted thatthere was some original justification for this figure. The original project/riskmanagement fee in the contractual payment profile amounted to £250,000,although this related to just the billing package and not the other componentsof the system. Consequential and indirect losses were also excluded under thecontracts. The turnkey contract also contained a warranty that the system wouldconform to South West Water’s defined requirements (ie the URS) for 90 daysafter acceptance, otherwise ICL would provide free upgrades and add-ons toremedy any defects.
The fact that ICL contracted under a turnkey agreement, which was supposed torelate to a situation where a ready- made system would be supplied to South WestWater, worked against ICL. The trial judge commented that the only real issuefor a genuine turnkey system was whether it would or would not pass theacceptance test procedure, hence entitling the customer to reject an entiresystem. ICL was nowhere near delivering the entire system when South West Waterterminated the contracts, and so ICL argued that on the strict wording of thecontracts its liability was capped at £250,000.
Application of UCTA
The court found that the parties had contracted on ICL’s standard terms andconditions in relation to the relevant limitation clauses. Although South WestWater had offered its own terms and conditions initially, these had beenrejected by ICL and the limitation clauses were taken from an ICL systems supplyagreement. ICL later accepted an annotated version which reflected the changesin the conditions sought by South West Water. The trial judge relied upon, amongother things, an extract from Chitty on Contracts on the issue of whatconstitutes standard terms. This states that no two contracts are likely to becompletely identical because they would differ as to subject matter and price.On these grounds he found that the changes to the limitation terms were so minoras to not defeat the argument that the parties had contracted on ICL’sstandard terms. He also relied on and followed St Albans – negotiationswhich left parts of the defendant’s (in that case also ICL’s) generalconditions untouched could still result in the parties concluding a contract onICL’s written standard terms. The fact that the South West Water contractscontained extracts from the terms and conditions of both parties, and theparties had negotiated extensively on other aspects of the contracts, did notassist ICL as the limitation clauses were taken from their standard terms andhad not been effectively amended. Accordingly it was held that the parties hadcontracted on ICL’s standard terms for the purposes of UCTA.
Therefore the contracts fell within s 3 of UCTA, and ICL had to satisfy thecourt that the limitation clauses upon which it was relying were fair andreasonable in accordance with the tests set out in s 11 of UCTA (which again, Iwill assume, readers of this article are familiar with). The trial judge,relying on the fact that the turnkey contract was inappropriate for the project,held that the limitation clauses denied South West Water an effective remedy inthe face of ICL’s breaches, as the limit of £250,000 was manifestly unfair inthe face of the risks on the project. The clauses were therefore held to beunenforceable. Further, all the limitation clauses fell together and were heldto be unenforceable because they were unreasonable. The arguments which ICL putforward about the negotiations taking place at arm’s length were alsorejected.
Restitution
South West Water contended that it had received no benefit or considerationfrom its payments to ICL whatsoever and that, under the law of restitution andthe case of The Fibrosa [1943] Ac 32, the monies still belonged to SouthWest Water, and it was therefore entitled to a full reimbursement of the moniesit had paid to ICL. However in order for this argument to succeed, South WestWater had to show that there had been a total failure of consideration, or‘that it did not get any part of which it had paid its money for’ (the testset out in Rowland v Dival [1923] 2 KB 500). The court found that thehardware ICL delivered under the contract was useless because it could not beused without the software which ICL was unable to deliver. The court alsoaccepted South West Water’s argument that the project management and trainingservices which ICL provided were of no value in the context of the failures onthe project. South West Water’s restitution claim succeeded on the groundsthat there had been a total failure of consideration by ICL in relation to theproject in terms of what it contracted to provide to South West Water.
Conclusion
Apart from the obvious conclusion that suppliers should not recklessly enterinto contracts which they cannot perform, and then expect to hide behindinappropriate limitation of liability clauses to avoid their liability, onecannot help feeling from reading the decision that the judge was so irritated atICL’s conduct that he would have struck down the limitation clauses by anylegal argument open to him. Having said that, the result, on liability at least,seems to be common sense. It is interesting to note that ICL is appealing thedecision, presumably on the UCTA and restitution points, and one would imaginemuch more legal argument is to come. The contracts that came under the court’sscrutiny were drafted in 1994 before ICL’s unfortunate draftsmen would havehad the benefit of the outcome of the decisions in Thomas Witter and StAlbans, and so one assumes that drafting practices have long since changedamong suppliers. It will also be interesting to hear what arguments are advancedand succeed when South West Water is awarded its total damages on the case. Thisis a case to watch.
An Inside view of the South West Water v ICL case John Rubinstein and Sarah Harrop from Manches IP/IT Group add their comment. Manches represent South West Water in the case. Recent trade press comment by lawyers for ICL makes it seem that South West Water v ICL has momentous legal importance for computer systems suppliers and users. We disagree. Regrettably for lawyers, the facts of the case as found by the court were so peculiar to the project that little of legal precedent value is likely to be strained from the case to apply to other fact situations. In the event the Court of Appeal disagrees with the learned judge’s findings of fact, the same law would nevertheless be applied to the case. Just extracting a couple of the unusual features of the case – How often has a computer systems contract been found by a court to have been entered into on the basis of a reckless misrepresentation ? How often does a supplier enter into such a contract against the express advice of its key sub-contractor ? The real importance of the case may not lie in the legal alleys which were pursued before His Honour Judge Toulmin, but it represents a cautionary tale for suppliers eager to close out the competition and secure strategically impressive contracts without adequate regard to risk and price; and who, when the contract has become impossible despite all bona fide efforts to perform, fall back on every available argument including exclusion and limitation clauses to avoid paying any compensation to the user. ICL is not appealing against the judge’s ruling that it is liable for breach of contract and that SWW was entitled to terminate the contract; the appeal focuses almost exclusively on the level of damages, and ICL are seeking leave to appeal the judge’s factual finding that there had been a reckless misrepresentation. The case did not turn on expert evidence, and neither party’s expert was ultimately called. The issue of expert evidence arose only because of a number of ICL’s pleaded defences (subsequently abandoned before or at trial) as to the nature of the system which had been contracted for (whether it was bespoke or a modified package) and the methodology of the contract (whether the supplier or the user was responsible for delivering the system). Whilst established legal principles were applied to the facts, as found by the judge, the lessons for computer suppliers, regardless of the outcome of the appeal, seem to be:
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