Exclusion and Limitation Clauses in IT Contracts

Mark Davis is a partner with solicitors Curtis Davis Garrardbased at London Heathrow. Tim Strong is a Senior Associate at the firm. The firmspecialises in project and dispute work in the shipping and off-shore sectors.Mark Davis led the successful team representing Pegler in the case of Pegler Ltdv Wang (UK) Ltd which was heard in the Technology and Construction Court on 25February 2000.

Commercial contracts typically include provisions to limit or exclude liabilityin the event that there is some failure by the supplier in performing thecontract, or some defect in the goods or services supplied. IT contracts are nodifferent.

In Pegler Limited v Wang (UK) Limited, His HonourJudge Peter Bowsher QC had to decide a number of interesting points ofconstruction of such provisions, in the context of formal admissions by Wang -not made until two and a half years after Pegler had commenced proceedings -that it committed over 500 individually identified breaches of contractamounting to a wholesale failure to provide Pegler with the integrated computerhardware and software and associated services for which it had contracted to payin excess of £1 million. The judge also considered the reasonableness of suchexclusion and limitation clauses under the Unfair Contract Terms Act 1977 (UCTA),highlighting the potentially dangerous consequences for IT suppliers of‘overselling’ their systems and related services.

This article analyses the judge’s treatment of theexclusion clauses in the contract between Pegler and Wang.

Construction

For the sake of convenience, the construction issues will beconsidered under three headings:

• exclusion clauses and non-supply
• exclusion of consequential loss
• exclusion of loss and continuing breach.

Clause 5.15 of the contract contained the relevant exclusionof liability clauses.

Exclusion clauses and non-supply

It was argued on behalf of Pegler that clause 5.15.6 appliesonly after the product has been supplied. Clauses 5.15.2, 5.15.3, and5.15.4 (none of which was relied upon by the defendants) all relate to liabilityarising after supply, and the same scheme is maintained in clause 5.15.6 suchthat there could be no functioning or use of the hardware or software until afterit has been supplied. As such the clause refers to supply, not non-supply orlate supply.

Wang argued on the other hand that clause 5.15.6 refers toclaims which can arise only if, in some respect, there has been a failureto supply, function or provide use in accordance with Wang’s contractualobligations.

In considering those opposing submissions, Judge Bowsher borein mind that the burden of proof was on Wang to show that the claims come withinthe exclusion of liability provision on its true construction (TheGlendarroch [1894] P 226 at 231 per Lord Esher), and pointed out that thecourt will be reluctant to ascribe to an exemption clause a meaning whicheffectively absolves one party from all duties and liabilities. (SuisseAtlantque v Rotterdamsche Kolen Centrale [1967] 1 AC 361 at 432). He alsotook into account the general words of Lord Hoffman as to the approach to theinterpretation of contractual documents in the recent case of Investor’sCompensation Scheme Limited v West Bromwich Building Society [1998] 1 WLR898 at 913.

With these considerations in mind, he accepted Pegler’sargument that clause 5.15.6 is not meaningless if it refers only to supply andevents after supply. He held that the whole of clause 5.15 envisages firstsupply and then function and use and provision of services. If Wang had wishedto exclude liability for delay in supply or failure to supply, they should havesaid so. In fact, the parties did make explicit provision for delay in supplyand failure to supply, in a different term of the contract, which provided that‘Neither party shall be liable to the other for any delay in or failure toperform its obligations hereunder (other than a payment of money) provided thatsuch delay or failure is due to causes beyond its reasonable control.’

Since Wang did not suggest that its delays and failures weredue to causes beyond its reasonable control, liability for those delays andfailures was not excluded, and that result was held by the judge to sit neatlywith his reading of clause 5.15.6 which he held did not exclude liability forWang’s delays and failures before supply.

It is clear from the judge’s decision that, in the absenceof clear wording, the court will not be sympathetic to a party who seeks toavoid liability for his delay in or failure to supply.

Exclusion of consequential loss

Clause 5.15.6 expressly excludes liability for ‘indirect,special or consequential loss, howsoever arising (including but not limited toloss of anticipated profits or of data)’. The reference by the words inbrackets to loss of anticipated profits did not mean that the exclusion effectedby this clause includes all loss of profits: it was plain from the context thatonly loss of profits which are of the character of indirect, special orconsequential loss are referred to. As was explained in Victoria Laundry vNewman Industries [1949] 2 KB 528 at 536, claims for loss of profits mayfall into either the first or the second rule in Hadley v Baxendale(1854) 9 Ex 341 depending on the circumstances. Judge Bowsher acceptedPegler’s argument that those words, particularly when taken with the words,‘even if Wang shall have been advised of the possibility of such potentialloss…’ at the end of the clause refer to loss under the second limb of Hadleyv Baxendale whereas the loss claimed by Pegler came under the first limb of Hadleyv Baxendale.¹

This is the latest decision upon an exclusion of liabilityfor ‘consequential loss’. Despite the words in brackets (which, thedefendants argued, made it plain that all loss of profits was excluded), JudgeBowsher followed the distinction drawn in the earlier cases between loss ofprofit falling within the first limb of Hadley v Baxendale (ie thosewhich flow as a natural consequence from the defendant’s breach of contract)and those within the second limb (i.e. those which are ‘special’ in thesense that they could not have been anticipated by the defendant, such as thosethat would arise from an exceptional and particularly lucrative contract).

It follows from this decision that, if one of the partieswishes to exclude liability for loss of profits that arise in the other’snormal course of business, clear words must be used. An exclusion of‘indirect, special or consequential loss’ will be ineffective to excludesuch liability.

Exclusion of loss and continuing breach

Clause 5.15.7 imposed a contractual limitation period for thecommencement of actions, providing that no action may be brought ‘more thantwo years after the cause of action has occurred’. Judge Bowsher agreed that acause of action which arises in respect of late delivery of a module arises whenthe failure or delay first occurs, if the complaint is of damage causedby the delay. But delay in delivery is a continuing breach and there is a freshcause of action every day until the duty to perform ceases by acceptance ofrepudiation or in some other way (Johnson v. Agnew [1980] AC 367 at 398-9and Segal Securities Limited v. Thoseby [1963] 1 QB 887 at 901-2).

Where late delivery is complained of, the damage arising fromthe first day alone is likely to be so small that it would be disregarded ifdelivery were effected on the next day. The parties as commercial men could nothave intended that the term should be read as if the words were ‘more than twoyears after the cause of action or any similar cause of action firstoccurred’. Performance in this contract (including the giving ofpost-installation services) was intended to continue over a number of years. Itcannot have been intended that Pegler should be forced to begin proceedings topreserve its rights at a time when performance from Wang was still due and beingoffered. Judge Bowsher thus concluded that legal refinements should beoverlooked in the construction of the clause, and a continuing breach should beregarded as one cause of action with the two-year period beginning when the dutyto perform ceases either by performance or termination of the contractual dutyto perform. Similarly with total failure to perform: the breach continued untilWang’s repudiation was accepted.

This construction is a victory for common sense. It allows aparty in any project which is to continue over a number of years to work withhis contractual partner towards completion of the project, safe in the knowledgethat in the event that performance subsequently ceases and/or the contract isterminated they will not be prevented by such a clause from recovering damagesfor earlier and continuing breaches.

Reasonableness and ‘Overselling’

Pegler pleaded that even if the clauses 5.15.6 and 5.15.7 didoperate, as a matter of construction, to exclude any of the loses claimed, theywere unreasonable and unenforceable pursuant to UCTA. Having decided theconstruction questions in Pegler’s favour, it was not strictly necessary forJudge Bowsher to consider the UCTA issue. However, in case of an appeal, he didso. Having decided that UCTA applied to the contract between Pegler and Wang, heconcluded that the exclusion clauses were unreasonable.

The test of reasonableness under UCTA requires considerationof the circumstances known, or which ought to have been known, to the parties atthe time they concluded their contract. In this case, Pegler argued that therewas an important imbalance in the parties’ knowledge at the time the contractwas concluded which rendered Wang’s reliance on the exclusion clauses unfairand unreasonable.

Before contract, Pegler had issued a detailed invitation totender (ITT), setting out the functional requirements for the new system andasking for potential suppliers to indicate the degree of ‘fit’ to thoserequirements which their solution offered. Pegler stated that they wished toimplement a ‘tried and tested’ solution, rather than become involved in newsoftware development. They recognised that no software was likely to be able tobe used and implemented without adaptation to their needs, but also that thegreater the need for adaptation or bespoke programming, the greater the risksinvolved. They were concerned to minimise the risks and Wang were aware of this.

In responding to the ITT, Wang acknowledged that the ITT setout all the information they needed to design and implement the new system,represented that their proposed solution provided a high degree of ‘fit’ toPegler’s requirements and stated on various occasions that implementing theirsolution would be ‘low risk’. The representation that their solution was‘low risk’ was repeated by Wang in correspondence leading up to thecontract.

The implementation failed for many reasons, not least ofwhich were Wang’s extensive breaches of contract. However, it gradually becameclear during the proceedings that a contributing factor was that Wang’ssolution was in fact high risk. They had taken a cavalier approach to respondingto the ITT, seriously overstating the ‘fit’ of their proposed solution toPegler’s requirements and the amount of bespoke programming that would berequired. Internal Wang analyses of the functionality requirements in the ITT,undertaken before the response was issued, showed that certain requirementscould not be met by the software proposed without modification. However,Wang’s response to the ITT stated that the standard software was a perfect‘fit’ to those requirements. Further, there were almost 100 specificfunctionality requirements where Wang acknowledged in their initial defence thatbespoke programming was required, but in respect of which their response to theITT had claimed a perfect ‘fit’.

Pegler argued that it was not reasonable for Wang to rely onthe exclusion clauses in circumstances where they knew or had the means ofknowing, before contract, that the risks to a successful implementation of theirsolution were much higher than they had led Pegler to believe.

Judge Bowsher accepted Pegler’s argument. He held that itwould be one thing for Wang to rely on standard terms intended to excludeliability for some not readily foreseeable lapse on their part, but quiteanother to do so when they had so misrepresented what they were selling thatbreaches of contract by them were not unlikely.

UCTA makes it clear that whether an exclusion or limitationclause is unreasonable will depend on the circumstances of each case. However,the courts have not been averse to establishing ‘principles’ to guideconsideration of the issue and this decision effectively creates a new‘principle’. An exclusion or limitation clause may be unreasonable where (a)the contract is preceded by express statements to the purchaser as to the natureand quality of what is to be supplied, (b) the supplier knows, or has the meansof knowing, that those statements misrepresent the true position and (c) thepurchaser relies on the statements in deciding to contract.

The Pegler ‘principle’ may also allow apurchaser/claimant, in appropriate cases, to rely on misrepresentations beforecontract to improve his position when claiming damages for breach of contract.It is not uncommon for a purchaser to be in a position where he has the choicewhether to claim damages for misrepresentation or for breach of contract. Thepurchaser will often prefer to claim the latter, where the measure of damagesmay be significantly more favourable. The measure of damages for breach ofcontract is designed to place the claimant in the position he would have been inhad the contract been performed. In other words, he is compensated for loss ofthe benefits that would have flowed from performance of the contract and foradditional expenditure incurred in mitigating the supplier’s breaches. Thismay include, using Pegler as an example, compensation for lost sales and lostreductions in headcount, inventory, debtors and purchasing costs, as well as thecost of purchasing and implementing a replacement system. Contrast this with themeasure of damages for misrepresentation, which merely looks to place thepurchaser in the position he would have been in had the misrepresentation(s) notbeen made. This usually means that recovery is limited to the cost of enteringinto the contract and may be limited to the price paid. It does not extend toallow compensation for loss of expectation. If, therefore, the purchaser’sability to claim the larger amount is on the face of the contract restricted byexclusion or limitation clauses, the Pegler ‘principle’ may enable him toovercome that difficulty and recover greater compensation than would otherwisebe available.

This ramification of this decision will perhaps be mostkeenly felt in the IT sector, which has gained a poor reputation over the yearsfor over-stating in bid documents (in an attempt to win contracts) thecapabilities of systems, the benefits purchasers can expect to derive from theirimplementation and the skills of the resource available to ensure projectsuccess. Save when contracting for projects at the larger end of the scale andwith purchasers with the financial muscle to secure more favourable terms, theindustry also relies very heavily on standard terms and conditions (and,therefore, standard exclusion and limitation clauses), which are more likely tobe subject to UCTA. For example, it is widespread practice to limit any damagespayable for breach of contract to the contract price. Wang did not seek to relyon such a limitation, but the case nevertheless illustrates very clearly thedangers of ‘overselling’. The contract price was just over £1 million, butPegler were awarded over £9 million in damages for lost benefits and additionalexpenditure caused by Wang’s breaches.

Conclusion

The treatment by Judge Bowsher of the exclusion clauses inthe contract between Pegler and Wang, whilst important in the IT sector, has farwider implications that will impinge upon the rights and liabilities of partiesto any long and complex projects where there is a similar attempt to exclude orlimit the liability of the supplier/builder. Parties to such contracts would bewell advised to ensure that they have an accurate understanding of the legalmeaning of such clauses in order that they may avoid any potential liability forlosses which will often be out of all proportion to the contract price.

Similarly, there is no obvious reason why the Pegler ‘principle’as to the reasonableness of exclusion clauses should not apply to any case of‘overselling’ of goods and services where UCTA applies to the contract. Allsuppliers would therefore do well to take steps to ensure, for example throughstaff training and careful monitoring of sales literature, brochures and biddocuments, that pre-contract representations about what they are selling do notoverstate what it is proposed to provide or understate the risks of the proposedtransaction to the purchaser.

^Endnote

^{1. See Croudace Construction Limited v Cawoods [1978] 2 LloydsRep 55; Miller’s Machinery Co. Limited v David Wray & Son (1935) 40Com Cas 205; Deepak Fertilisers and Petrochemicals Corporation v ICL[1991] 1 Lloyds Rep 387 at 402-403; British Sugar plc v NEI Power ProjectsLimited and anr (1997) 87 BLR 45; Saint Line Limited v RichardsonsWestgarth & Co [1940] 2 KB 99 at 104-105; and Wraight Limited v PH& T (Holdings) Limited (1968) 13 BLR 29 at 35.}