Anyone reading this article will surely be aware of the potential for IT projects to go wrong when there is a mismatch between what is promised by the supplier or required by the buyer and what is actually delivered. A large proportion of IT projects do not run to time, are over budget or fail to meet the agreed specification. A supplier involved in an unprofitable contract may also consider the option of walking away even if this places it in deliberate breach. If the dispute is significant enough and the parties end up in litigation, the first clause that is pored over is the liability clause that seeks to exclude or limit liability for something going wrong.
In the recent case of AstraZeneca v Albermarle International [2011] EWHC 1574 (Comm), the High Court has given an interesting ruling on whether someone is deemed to have excluded or limited their liability for their deliberate repudiatory breach. In doing so, it has re-examined the judgment in the 2009 case of Internet Broadcasting Corporation (t/a NetTV) v Mar LLC (t/a MARHedge) [2009] EWHC 744 (Ch). In that case, the High Court had ruled that there was a rebuttable presumption that a liability clause should not apply to a deliberate personal repudiatory breach of a contract. The High Court had said then that extremely clear drafting would be needed for a court to rule that the parties intended an exclusion clause to cover a deliberate personal repudiatory breach and that there was a presumption that a party would not intend to limit their liability for really serious deliberate breaches (such as deliberately walking away from a binding contract).
Another commonly argued point with liability clauses involves the contra proferentem rule – the common law interpretation of liability clauses under which any ambiguity is interpreted against the party looking to rely on the attempted exclusion or limitation on liability. AstraZeneca v Albermarle does not break new ground but it does serve as a very useful reminder of the rule and how it can be applied.
As if that is not enough to take the IT law practitioner’s interest, the case serves up an interesting interpretation of what is meant in a contract by a right of first refusal. And then there’s a point about waiver and continued negotiation to try to make things work through a breach and whether rights are waived – a common scenario when IT projects go wrong.
The Facts
Despite this case relating to the supply of pharmaceutical products, the principles contained in the ruling apply to all contracts, including those in the IT sector. That said, it is worth having a brief look at the facts to understand the implications.
The supplier, Albemarle International (AI), entered into an agreement to supply products to AstraZeneca (AZ) – let’s call them Product X. AZ distilled Product X to create Product Y. AZ foresaw that it might in the future want to be supplied with Product Y rather than Product X.
AI therefore included a ‘right of first refusal’ provision in the agreement should AZ wish to order Product Y instead of Product X. The relevant clause stated that, in such an event, AI would have the ‘first opportunity and right of first refusal to supply [Product Y] to [AZ], under mutually acceptable terms and conditions’.
AZ later told AI of its intention to enter into an agreement with a third party (‘S’) for the supply of Product Y. AI objected as it wanted to continue to supply and cited the first refusal provision in the agreement. Negotiations ensued, but, despite AI matching the third party’s offer of supply, no agreement was reached, and AI served notice to terminate for AZ’s breach of the first refusal provision which had not been remedied on demand.
During the negotiations, AZ attempted to stockpile the goods, whilst AI refused to supply two additional orders made by AZ under the agreement, although this did not affect AZ’s operations. As with the fall-out from failed IT projects, finger-pointing ensued and both parties alleged that the other had breached the agreement.
AZ issued proceedings against AI for breach of contract as AI had failed to supply the two additional orders. AZ argued this was a repudiatory breach entitling AZ to terminate the agreement and claim damages. AI denied the claim, and further argued that any liability it might have was, in any case, limited by the liability clause in the agreement. AZ argued that AI could not rely on the liability clause because (following the ruling in NetTV v MARHedge) the breach was deliberate and repudiatory. AI then counter-claimed for breach of contract due to the alleged failure to give it first refusal on the right to supply Product Y, but AZ denied liability.
The Ruling
Mr Justice Flaux in the High Court ruled that AI was, on the facts, in breach to AZ for its failure to fulfil one of the two additional orders and was liable in damages for that breach. However, he went on to rule that failure in respect of one or two orders did not amount to a repudiatory breach of a contract that was expected to continue for at least three years – the seriousness of the breach was assessed having considered the effect of the breach on the contract as a whole.
Meanwhile, Flaux J decided that AZ was also liable for failing to honour the first refusal provision and AI was entitled to terminate the contract as a result of that breach.
Having found that there was breach by both parties, the judge had to decide whether the liability clause excluded or limited the liability of either party and, in particular, whether AI could claim for its loss of profits despite an apparent provision excluding liability for lost profits. Meanwhile, although AI’s failure to supply was not serious enough to be repudiatory and although the breach was not deliberate (as AI had received legal advice that suggested that it would not be breaching the agreement in the circumstances by failing to supply), the court went on to consider the issue of deliberate repudiatory breach anyway.
Right of first refusal
AZ had argued that the right of first refusal clause was too uncertain to have contractual effect, thereby freeing it of any obligation to offer AI first refusal on the supply of Product Y. The High Court disagreed, and ruled that, in such a situation where the parties have gone to the effort of including such a clause, a court should try to give the clause some commercial meaning. The inclusion of the words ‘under mutually acceptable terms and conditions’, rather than rendering the clause ineffective as argued by AZ, simply meant that negotiations would be needed before a binding contract for the supply of Product Y could be entered into by the parties.
The High Court ruled that, where AZ had decided to move to buying Product Y and it was considering an offer to supply from a third party, AZ was under an obligation to provide AI with a reasonable opportunity and sufficient information to offer the same terms as those offered by S. Whilst negotiations might have meant that AI would not offer to supply on the terms offered by S, if AI was willing to match the terms that AZ was minded to accept from a third party (as happened here) then AZ was obliged to accept AI’s offer. The right of first refusal clause had to mean something. AZ was obliged to provide full disclosure of the terms of the proposed deal with S and act in good faith towards AI.
The only sensible construction of a right of first opportunity was to give AI sufficient opportunity and right to match the offer and not, as AZ had argued, that this obligation to make the offer of the right to first refusal arose only when AZ was about to enter into a contract with S. The High Court ruled that AI had to be given a genuine opportunity, and that this arose on the day on which the tender process run by AZ for the supply of Product Y ended. As such, AZ was in breach of the right of first refusal clause, and AI had rightly given AZ 30 days to remedy the breach and then rightly terminated the contract after the breach had not been remedied.
Waiver
However, did the fact that AI had continued negotiating after the 30-day cure period had expired amount to a waiver of its rights to terminate?
No, said the High Court. AI could still terminate despite not exercising that termination right immediately. In fact, Mr Justice Flaux made the point more fervently than that. He said: ‘AZ did have a pleaded case that, by continuing negotiations after 26 October 2007, [AI] somehow waived any right to rely upon the thirty day time limit in the letter of 26 October 2007 or to terminate the supply agreement on the basis set out in that letter. Wisely, that case was not pursued at trial, as it was utterly hopeless.’
If the point was not already made strongly enough by ‘utterly hopeless’, Flaux J added: ‘the mere fact that [AI] agreed to negotiate under clause H beyond 25 November 2007 does not in any sense amount to a waiver by [AI] of its entitlement to terminate the supply agreement under clause K for failure to remedy the breach of clause H within the 30 day period.’
AI was still entitled to terminate the agreement on 3 March 2008, over three months after expiry of the 30 day period.
Deliberate Repudiatory Breach
The High Court had already ruled that the breach by AI in failing to supply was not repudiatory. However, it went on to rule that, even if there had been a repudiatory breach by AI, the breach had not been deliberate as AI had followed legal advice that it was acting within its contractual rights (albeit the legal advice had been incorrect). It was the motive behind a breach, rather than the breach itself, that made the breach deliberate. As such, there was no question that the liability clause did not apply and it therefore limited AI’s liability.
Despite finding that AI’s breach was neither repudiatory nor deliberate, Flaux J still went on to consider what would have been the position had that in fact been the case. He said that the decision in NetTV v MARHedge had been misguided in ruling that liability clause protections do not apply to a party that deliberately chooses not to perform its contractual obligations. Rather, he stated that deliberate repudiatory breaches should not be treated any differently from any other breach. Flaux J said that, although it was not necessary to consider whether or not a liability clause applied to a deliberate personal repudiatory breach, he would be inclined not to follow NetTV v MARHedge if it did.
Limited ‘Contra Proferentem’ interpretation of liability clause in relation to breach of right of first refusal provision
The liability clause said: ‘No claims by [AZ] of any kind, whether as to the products delivered or for non-delivery of the products, or otherwise, shall be greater in amount than the purchase price of the product in respect of which such damages are claimed; and failure to give written notice of claim within sixty (60) days from the date of delivery, or in the case of non-delivery, from the date fixed for delivery, shall constitute a waiver by [AZ] of all claims with respect thereto. In no case shall [AZ] or [AI] be liable for loss of profits or incidental or consequential damages.’
AZ argued that it was not liable for AI’s lost profits arising out of its breach of the right of first refusal provision. However, the Court ruled that, in line with English law rules of interpretation on liability clauses, the liability clause had to be construed against the party seeking to rely on it if there was the slightest bit of doubt in the meaning (the ‘contra proferentem’ rule). The clause needed to be interpreted strictly but without any presumption, unlike the ruling in the NetTV case.
AZ’s interpretation would have meant that the first refusal provision would have been no more than a statement of intent, leaving AZ with no incentive to comply with it. A court would always seek to do everything to avoid such an effect unless there was no alternative construction.
In this case, an alternative construction was available. It was that the second sentence in the liability clause (ie the exclusion of lost profits) had to be read in the same light as the first sentence within the same paragraph – ie as applying to late or non-delivery of products. This was true even though the first part of the clause was an exclusion only relating to AI, whereas the second part of the clause related to both parties. On that interpretation, the liability clause related only to claims for late delivery or non-delivery of the current product; it was not intended to deal with loss of profits arising out of not giving AI the opportunity to supply Product Y.
Comment
This ruling is important because it deals with four issues that often crop up with IT disputes – narrow interpretation of liability clauses, the exposure if one party wants to deliberately walk away from a contract, the meaning of offering a supplier a right of first refusal and waiver during dispute negotiations.
The ruling in NetTV v MARHedge stated that deliberate repudiatory breaches can, in some circumstances, be covered by a liability clause but only if express words are used – a deliberate repudiatory breach will not be covered by a liability clause unless expressly stated. This ruling suggests the opposite, in that liability would be restricted or excluded for deliberate repudiatory breach just as much as with other forms of liability, and no specific wording would be necessary. Those comments are not strictly binding on future cases as that part of the ruling was obiter dicta. The High Court did not need to make a ruling on that issue – it had already ruled that the breach was not deliberate or repudiatory anyway. Technically, NetTV v MARHedge is still just as good law as it was, but Mr Justice Flaux wanted to put down a marker that he felt NetTV was wrong.
This uncertainty is not particularly helpful for businesses that need to know how best to draft contracts, but the best advice is to draft appropriate wording to reflect the level of risk the parties are willing to take and not leave it to the courts to decide. The applicability to the IT industry is clear – it is not uncommon to find a software supply agreement before the courts where the supplier has downed tools following a disagreement over scope creep or fixed or capped price issues where the project is more involved than had been envisaged. If a court can be convinced that the supplier has committed a deliberate repudiatory breach, the ruling in NetTV v MARHedge provided that there is a presumption that the liability clause will not apply to that breach, and liability could, for example, be unlimited. This ruling suggests that the liability clause will apply and liability for that deliberate repudiatory breach will be limited in the same way as accidental breach. At present, there is no certainty which decision should be backed and the best position is to clearly draft the intention of the parties to avoid the uncertainty. And of course suppliers should conduct more thorough due diligence to understand the scope before they say anything to win the contract and worry about the consequences later.
The part of the ruling dealing with the narrow interpretation of a liability clause against the party seeking to rely on it (the contra proferentem rule) – which meant that breach of the right of first refusal provision in the agreement was not covered by the liability clause – is actually just a very useful reminder of existing rules. Courts do not look favourably upon widely drafted liability clauses and will often apply the contra proferentem rule. (That said, as can be seen from the Court of Appeal ruling in Regus v Epcot [2008] EWCA Civ 361, that is not always the case.) Based on the courts’ views of achieving justice through the contra proferentem rule, the English law position would surely be this: if a clause allows a party to an agreement to intentionally fail to fulfil its contractual obligations and leave the other party to the contract without any meaningful remedy for that failure, that clause would be unlikely to be viewed favourably, but to say that the principle in the NetTV case stands and there is a rebuttable presumption that the liability clause will not apply to such a clause seems to be an assumption too far.
Practitioners should draft on the basis that a judge would try to find any chink in the armour of a liability clause and find an unfavourable interpretation. Clauses should be clearly divided into sub-clauses and sub-sub-clauses to enable severability and careful thought should be given to the proximity of one phrase or sentence near another. Where possible, different ground covered by different provisions within a liability clause should be carefully signposted, rather than concepts mixed together in one paragraph. Contract lawyers should play devil’s advocate when drafting a liability clause and try to understand what a court might see from the outside looking in, rather than just looking at what the draftsperson might wish the clause to say.
The interpretation of the phrase ‘right of first refusal’ was also extremely useful. That phrase is sometimes used in contracts but this ruling gives real insight into what that actually means. A party (A) giving another (B) a right of first refusal must communicate any relevant offer it receives from a third party to B. This leads to considerations relating to confidential information, particularly in relation to IT contracts where detailed knowledge of a system or another party’s capability may be disclosed in any discussion about the provision of services. If a confidentiality agreement is entered into between A and that third party for the purpose of negotiations, the agreement will need to specifically allow for the disclosure of the details of the third party offer by A to B. Further, if B makes an offer which matches that of the third party, A is obliged to accept it. It begs the question as to why anyone would want to invest time and money in negotiating if they know their competitor could always have the right to learn their commercial position and trump them without having to beat their offer.
Finally, the decision that one party had not waived its rights of termination when it continued to negotiate for a few weeks in good faith was also helpful.
All in all, this is a major judgment that affects all commercial dealings. We will have to see, though, whether the ruling will be appealed and, if so, whether any of the interesting points from the High Court will remain.
Paul Gershlick is a Partner and Simon Weinberg is a Solicitor in the Commercial/IP/IT Team at Matthew Arnold & Baldwin LLP
