Facts
This judgment arose out of a hearing concerned with preliminary
issues, although the facts are set out in some detail in both
judgments. The relevant background is as follows.
Watford sold electronic components, including computer products
(PCs and peripherals) by mail order and also at two retail
outlets. At the time of the contracts in question, its
turnover was around £21 million. The business had been
successful, by the time of the judgment turnover was around £25
million and the group of companies had a combined turnover of some
£100 million.
Sanderson was part of a group that in 1991 had a combined
turnover of over £60 million although Sanderson itself had a
turnover of only some £4 million in 1992. It supplied
systems, including systems incorporating a product known as
Mailbrain, a marketing package dealing with mail order processing,
database marketing, telemarketing and wholesale order
processing. As at 1992, there were 120 customers for
Mailbrain. Furthermore, Mailbrain was marketed as a product
that could be linked to other packages such as sales, purchase and
nominal ledger and payroll. It did this by a package called
Genasys, which was itself an integrated suite of financial
accounting packages. Sanderson had produced Genasys both as
an independent package and one which could be integrated with
Mailbrain.
In 1992, Watford moved into new premises to accommodate its
growth and quickly realised that it needed an integrated software
system to deal with its various areas of business – mail order,
retail sales, warehouse stock control and accounting. This
would facilitate the growth of the business and allow Watford to
provide a better service.
The two parties came into contact with each other at a roadshow
organised by Sanderson in February 1992. Watford had just
tried a different computer system where the implementation had
failed after a week, and was therefore keen to ensure that there
was no repetition of the experience. While there was some
dispute as to what was said in the meetings (and when), it was
clear that the brochure together with pre-contractual
correspondence and discussions would have left Watford with the
impression that the system as offered would be fully
integrated.
Another issue that was discussed was the hardware to be
used. Again, the content of the conversations was disputed,
with Sanderson’s salesman claiming he had only ever advised on the
disk space that was required. Judge Thornton found that
Sanderson had not advised on the need for a minicomputer as opposed
to PCs, in spite of the rising number of proposed users, and that
the supply of the hardware was therefore in the context of
Sanderson confirming that it was an appropriate specification for
the proposed applications.
At least one reference site visit was made, and a demonstration
took place at Watford’s premises. The demonstration led to
the requirement for at least some modifications.
In September 1992, there was a series of quotations from
Sanderson, which reflected the discussions between the parties,
especially as to price and the required modifications to Mailbrain
and Genasys. Sanderson was to supply Mailbrain, Genasys and
its EPOS (electronic point of sale) system, together with 17
specific modifications, and a licence for 100 users. The
hardware was supplied by both parties.
Sanderson had sent through its standard conditions with a letter
dated 23 September 1992 and these were discussed at a meeting on 28
September. Watford was concerned with the limitations of
liability, which excluded liability for consequential or indirect
loss and limited other liabilities to the contract price.
Watford observed in negotiations that it then had a monthly
turnover of £1.5 million, so any problems could cause considerable
harm. However, Sanderson said that the clauses were
non-negotiable and in the end only agreed to add a clause to use
best endeavours to allocate appropriate resources to the
project. Watford felt it had no option but to agree.
There were initially three contracts, dealing with sale of the
hardware, licensing the software and also a “software modification
licence”. The three contract forms all had similar wording in
them, and the one for the sale of equipment had these words (this
report will refer to this numbering, although the original
contracts had different numbers for the otherwise identical
clauses):
“Neither [Sanderson] nor [Watford] shall
be liable to the other for any claims for indirect or consequential
losses whether arising from negligence or otherwise. In no
event shall [Sanderson’s] liability under the Contract exceed the
price paid by [Watford] to [Sanderson] for the Equipment connected
with any claim.
In addition to [the clause at paragraph 1] Sanderson CFL commit
their best endeavours in allocating appropriate resources to the
project to minimise any losses that may arise from the
Contract. [this was the addendum agreed in
negotiations]
The parties agree that these terms and conditions (together with
any other terms and conditions expressly incorporated in the
Contract) represent the entire agreement between the parties
relating to the sale and purchase of Equipment and that no
statement or representations made by either party have been relied
upon by the other in agreeing to enter into the Contract.”
The system went live in February 1993, but demonstrated serious
problems even before that. This culminated in Sanderson
recommending that Watford acquire a minicomputer. Watford
executed two further contracts on 17 August 1993 for a Bull
minicomputer and an increase of the licence to allow 100
users. Both contracts included clauses (1) and (3) above, but
not (2).
Watford claimed for loss of profits (£4,402,694), increased
costs of working (£996,063) and the costs of acquiring an
alternative system (£119,204). There was an alternative claim
for misrepresentation and negligence comprising sums paid to
Sanderson (£104,596) and the increased costs of working
(£996,063).
Judgment
Judgment at first instance
Judge Thornton looked at the five contracts but concluded that
in reality there was one contractual relationship. It was not
realistic to break the contracts down into separate obligations to
supply software (with modifications), hardware, training and a
licence. The judge therefore thought that all the contracts
should be read together, so far as reasonably possible.
The contractual package involved providing goods, services and
software and so there was a “hybrid of implied terms”. For
goods and services, these are to be found respectively in section
14 of the Sale of Goods Act 1979 and section 13 of the Supply of
Goods and Services Act 1982. These were incorporated into the
various forms of contract in this case. Thus, there were the
following implied terms:
- The goods supplied would be of merchantable quality, namely as
fit for the purpose or purposes for which goods of that kind are
commonly bought as is reasonable to expect having regard to any
description applied to them, the price (if relevant) and any other
relevant circumstances.
- The services supplied would be carried out with reasonable care
and skill.
The contract could also have a further implied term:
- The goods supplied would be reasonably fit for any particular
purpose for which the goods should be acquired.
This last implied term depended on whether there was reliance by
Watford on Sanderson’s skill or judgment.
The question raised in particular was whether the software
itself had the implied terms of merchantability and fitness for
purpose. These could be implied by virtue of the contract for
supplying software being a bailment or by virtue of terms implied
at common law.
The definition of “software” in the contract included the
physical elements (of the medium) and so it could be regarded as a
contract to supply goods. This being so, the contract fell
within section 6(1) of the Supply of Goods and Services Act 1982
dealing with the hire of goods bailed. Section 9 of the same
Act provided for similar implied terms as under a sale of goods to
apply (again, dependent on showing reliance).
Turning to the position at common law, implied terms were such
as reasonably necessary to give business effect to the parties’
intentions. Since implied terms of merchantability and
fitness for purpose applied to the hardware element, it was a
business necessity for the software to have been supplied under
similar contractual arrangements. Judge Thornton did not
accept the argument that, under the common law, goods supplied
under a contract of hire did not carry with them strict implied
terms, but only an implied term that they should be as fit as
reasonable care and skill could make them.
In general terms, the implication of implied terms would apply
to such issues as compatibility and integration, although the full
trial would have to establish the exact scope of these
warranties.
Sanderson sought to argue that Watford, as a supplier of PCs and
other similar goods and a supplier of some of the hardware in this
case, was not relying on Sanderson’s skill and judgment. This
argument was rejected by the judge. He referred to all the
negotiations, including the brochure and the correspondence as
showing that Watford was clearly relying on Sanderson in its advice
and recommendations.
This was relevant given the judge’s finding that Sanderson’s
brochure and various items of correspondence did include
representations as to such matters as integration.
The clause at paragraph 3 was a clause that sought to exclude
liability for misrepresentation. Given that there had been
representations that induced the contract, the clause was in
substance an exclusion clause and subject to section 3 of the
Misrepresentation Act 1967.
Sanderson was contracting on its “written standard terms of
business” and thus fell within section 3 of UCTA. The fact
that one additional clause (paragraph 2) was included was not
sufficient to take the case out of section 3. The ambit of
the additional obligation added by the addendum was narrow and
insubstantial when seen against the remaining terms and
conditions.
Most of the losses were “indirect or consequential”, and the
combined limit of liability under the various agreements was about
£140,000. Watford was claiming direct losses of about
£120,000, but the bulk of its contractual claim (nearly £5.5
million) was made up of elements that were “indirect or
consequential”. The reasonableness of the exclusion was
therefore very important.
When looking at the question of reasonableness under UCTA,
Schedule 2 set out some guidelines which are of use, even though
they only strictly apply to sections 6 and 7. Looking at the
relevant guidelines and considering all the factors, Judge Thornton
thought the following.
- Both parties were of about the same size, and the
representatives who negotiated the contract each had considerable
experience. There was therefore no particular inequality of
bargaining power and neither party was under any particular
pressure to contract with the other.
- The market may have been a “buyer’s market” only to the extent
that Watford could negotiate the price down. In other ways,
having regard to the terms and conditions, Sanderson was relatively
inflexible in negotiating its liability clauses. There was
also evidence that such exclusions and limitations were standard at
the time.
- With regard to the competition, there were other packages
available, but Mailbrain was the only one which appeared to fulfil
Watford’s needs and there was no evidence to show that there was
any other integrated package available elsewhere.
- There was no evidence that Watford received any particular
inducement to accept the liability terms, and the price reduction
agreed seemed to have bearing on the matter. Judge Thornton
did not think that the fact of a price reduction reducing the
profit margin had any bearing on the reasonableness or otherwise of
the clause.
- Watford was aware of the existence of the clause, though only
at a late stage of the negotiations. The only amendment that
Watford could achieve was a “make-weight amendment”.
- While there were modifications, these were minor in comparison
to the standard system that was being supplied. In any event,
such work of modification was fairly standard for this type of
software.
- With respect to insurance, Sanderson had no general policy in
place. The evidence was that where Sanderson was forced to
change its liability provisions and accept some limited liability,
they took “one-off” insurance where they felt exposed. In
this case, Sanderson obviously assumed that Watford would sign the
contract without having to make the amendment. However, there
was no evidence that Watford could have obtained insurance to cover
its potential loss of profits resulting from Sanderson’s
failure.
- The fact that a discount was negotiated made no difference, as
it was not in any way referable to the exclusion clause.
- It was irrelevant that Watford’s own standard terms of business
excluded consequential loss: the businesses were very different,
and in any case Watford’s own exclusion might be held to be
unreasonable.
- It was also irrelevant to the question of reasonableness that
Watford had made a reference site visit and received a
demonstration. Neither would have enabled it to assess
whether acquiring such a system would be risk-free or not.
- Sanderson was contracted to supply and configure the
system. It was up to them to use their expertise to assess
the requirements. The fact that a salesman could not verify
all the facts from two visits did not mean that it was reasonable
for Sanderson to limit its liability for what was in reality
something within its own control.
- There were other factors as well: that Watford was dependent on
Sanderson’s expertise, that the exclusion clause effectively left
Watford without a remedy, that failure was potentially very serious
for Watford.
Taking all the factors together, Judge Thornton “unhesitatingly”
found that Sanderson had not established that the clause was
reasonable. It was not justified by any particularly onerous
or unusual liabilities that Sanderson might encounter, insurance
was available to Sanderson and Watford could not have obtained
software elsewhere without having to accept this clause since it
was so common at the time. The effect was to deprive Watford
of any damages where there had been significant failures by
Sanderson.
The judgment of the Court of Appeal (Chadwick LJ)
The appeal related only to the judge’s finding as to
reasonableness of the exclusion and limitation contained in
paragraph (1).
The Court followed the guidance given in George Mitchell
(Chesterhall) Ltd v Finney Lock Seeds Ltd [1983] 2 AC 803 as
to the approach an appellate court should take when reviewing a
lower court’s decision as to a view of what was reasonable.
The appellate court should treat the original decision with the
utmost respect and refrain from interference with it unless
satisfied that it proceeded upon some erroneous principle or was
plainly and obviously wrong.
In determining the reasonableness of the term, it is first
necessary to determine the scope and effect of that term as a
matter of construction. In particular, it is necessary to identify
the nature of the liability which the term is seeking to exclude.
The reasonableness of the term does not fall to be considered in
isolation. It falls to be determined where a person is seeking to
rely upon the term in order to exclude or limit his liability in
some context to which the provisions of UCTA or section 3 of the
Misrepresentation Act 1967 apply.
The two sentences in paragraph (1) are each intended to have
their own separate and distinct purpose. The purpose of the first
sentence is (at least) to exclude contractual claims for indirect
and consequential losses; that is to say, to exclude liability in
contract for losses which could be recovered only under the second
limb of the rule in Hadley v Baxendale. These are losses which do
not result “directly and naturally” from the breach, but which
nevertheless, were or must reasonably be supposed to have been in
the contemplation of both parties at the time the contract was
made.
The second sentence was an attempt to limit the liability for
loss directly and naturally resulting from breach of warranty to
the price of the equipment/software, so avoiding an enquiry into
what would have been the value of the equipment/software if the
warranty had been fulfilled. This corresponded with the
warranties given in Sanderson’s terms – that the hardware should
“perform in accordance with its specification” and the software
would “during normal use perform the functions detailed within the
manuals supplied”.
This should be compared with the rule in section 53(3) of the
Sale of Goods Act 1979, which says that in cases of breach of
warranty, the prima facie measure of loss is the difference between
the value of the goods at the time of delivery and the value they
would have had if they had fulfilled the warranty.
Thus, Sanderson’s terms sought to limit liability for breach of
warranty to the price of the equipment or software, that is to say,
they tried, in the context of section 53(3) to peg the value which
the goods would have had if the warranty had been fulfilled to the
price paid by the buyer.
The purpose, therefore, of the first sentence of paragraph (1)
was to exclude contractual claims for indirect and consequential
losses i.e. those things that could only be claimed under the
second limb in Hadley v Baxendale. These would comprise
losses not flowing directly and naturally from the breach, but
which nevertheless were or must reasonably be supposed to have been
in the contemplation of the both parties when contracting.
The entire agreement clause at paragraph (3) coloured the
meaning and effect which the parties must be taken to have intended
should be given to paragraph (1).
Chadwick LJ observed how entire agreement clauses and the effect
of an acknowledgement of non-reliance had been considered by the
Court of Appeal in Grimstead v McGarrigan (unreported 27
October 1999). The acknowledgement of non-reliance seeks to prevent
the person to whom the representation was made, not from asserting
a representation was made or was false, but from asserting that he
relied on it. This is important in the context of
commercial certainty and the parties being able to measure the
risks and agree the price of the contract on the basis of the
warranties given.
In the present case, the importance of the paragraph (3), is
that the first sentence in paragraph (1) has to be construed on the
basis that the parties intended that the whole agreement was to be
contained or incorporated in the document which they signed and on
the basis that neither party had relied on any pre-contractual
representation when signing that document. The first sentence
of paragraph (1) therefore did not apply to negligent
pre-contractual misrepresentations.
Judge Thornton made three errors which vitiated his
conclusion.
The true scope and effect of the limit of liability in paragraph
(1) was more limited than Judge Thornton seemed to recognise.
Paragraph (1) did not exclude or restrict liability for
pre-contract misrepresentation, whether under statute or common
law.
Given the purpose and effect of the term in paragraph (1), the
relevant questions were:
- was it fair and reasonable, having regard to the circumstances
which were, or ought reasonably to have been in the contemplation
of the parties when the contract was made, to include a term which
sought to exclude contractual claims for indirect and consequential
losses? and
- was it fair and reasonable, having regard to those
circumstances, to include a term which sought to restrict loss
directly and naturally resulting, in the ordinary course of things,
from breach of warranty to the price paid for the equipment or
software?
The obligation to use best endeavours to allocate appropriate
resources to minimise any losses that might arise under the
contract was confined to losses resulting from breach of
warranty. However, it plainly extended to all losses arising
from breach of warranty, including indirect or consequential
losses. If Sanderson did not use its best endeavours to allocate
appropriate resources to ensure the software performs the specified
functions, it could not rely on the provision excluding claims for
indirect or consequential loss. If they had used best endeavours,
then such losses would fall on Watford.
The judge’s view that this addendum was a “make-weight
amendment” was not an apt description of its effect.
Watford had its own standard terms and conditions of sale with a
limitation of liability clause similar to the first sentence of
paragraph 1. The relevance of this was to show that Watford was
well aware of the commercial considerations which led a supplier to
include a provision restricting liability for indirect or
consequential loss. In particular, Watford was well aware
that a supplier would be likely to determine the price at which it
was prepared to sell its products by reference (among other things)
to its exposure to the risk of unquantifiable claims for indirect
or consequential losses which might be suffered by the customer if
things went wrong. This had a direct bearing on reasonableness.
The Court considered reasonableness in relation to each limb of
paragraph (1).
As for the term excluding indirect loss, it is important that
the term did not exclude loss resulting from pre-contractual
statements in relation to which a claim lies (if at all) in tort or
under the Misrepresentation Act and that the addendum meant that it
did not exclude indirect or consequential loss resulting from
breach of warranty unless Sanderson has used its best endeavours to
ensure compliance with the obligation to provide appropriate
resources.
Looking at UCTA’s Schedule 2 guidelines, factors in favour of
reasonableness were:
- The parties were of equal bargaining strength
- The inclusion of the term was likely to affect Sanderson’s
pricing decision
- Watford must be taken to appreciate that
- Watford knew of the term, and must be taken to understand its
effect
- The product was to some extent modified to meet Watford’s
precise needs
Other factors pointed in the opposite direction:
- Mailbrain was the only package which appeared to meet Watford’s
needs
- Watford could not reasonably have expected to have been able to
acquire a similar software package on better terms
When considering whether an exclusion of indirect loss was fair
and reasonable, the following factors were relevant:
- There is a significant risk that a non-standard software
product that was modified to Watford’s precise requirements might
not perform to the Watford’s satisfaction
- There is a significant risk that the customer might not make
the profits or savings which it hoped to make (and might incur
consequential losses arising from the product not performing
correctly)
- Those risks were or must reasonably have been in the parties’
contemplation when contracting
- Sanderson was in a better position to assess the risk that the
product would fail to perform
- Watford was in a better position to assess the amount of the
potential loss if the product failed to perform
- The risk of loss was likely to be capable of being covered by
insurance, but at a cost
- Both parties would have known, or ought reasonably to have
known, when contracting that the party that would bear the risk of
loss (or would bear the cost of insurance) was one of the factors
influencing price
It was reasonable to expect that the contract would deal with
the risk of where consequential or indirect loss should fall.
Where experienced businessmen representing substantial companies of
equal bargaining power negotiate an agreement, they may be taken to
have had regard to the matters known to them. They should be
taken to be the best judges of the commercial fairness of the
agreement which they have made, including the fairness of each of
the terms in that agreement and whether the terms are
reasonable. The court should not assume that either is likely
to commit his company to an agreement which he thinks is unfair, or
which he thinks includes unreasonable terms. Unless satisfied
that one party has, in effect, taken unfair advantage of the other
– or that a term is so unreasonable that it cannot properly have
been understood or considered – the court should not interfere.
The parties did negotiate as to price and Watford did obtain
substantial concessions on price from Sanderson. There was
some negotiation about the liabilities, and although Watford did
not get what it wanted, it did get something of value. It
would be impossible to hold that Sanderson took unfair advantage of
Watford or that Watford did not understand and consider the effect
of the term excluding indirect loss.
The term excluding indirect loss was therefore a fair and
reasonable one.
As to the second sentence of paragraph (1), all it does is
substitute a value equal to the price paid by the buyer for the
goods for the “value which the goods would have had if they had
fulfilled the warranty” under section 53(3) under the Sale of Goods
Act 1979 (or the equivalent rule at common law). It would be
impossible to hold that this was an unfair or unreasonable
substitution to make in a case like this.
Commentary
This judgment at first instance was given on 27 July 2000
although the case did not seem to receive much attention. It
is the last of four cases that had sent shock waves through the
computer industry, with suppliers questioning whether they could
limit or exclude any of their liability without it falling foul of
UCTA. Given the importance of the case to the IT industry, an
expanded commentary is provided here.
The process had started with South West Water v ICL, had been
confirmed in Pegler v Wang, and was repeated in Horace Holman v
Sherwood International. The same has also been seen at first
instance in Watford Electronics v Sanderson. It appeared that
the judges of the Technology and Construction Court seemed
determined to use UCTA to undo limitations and exclusions agreed by
parties in contracts for IT systems implementation or
integration. The result: four cases from the TCC, all
decisively in favour of the user against the supplier.
The judgment of the Court of Appeal in Watford Electronics
represents nothing less than a seismic shift in judicial attitudes
and its lessons must be carefully learned and incorporated into
drafting and sales/procurement processes. First, it is
necessary to put all these decisions in context.
Where does this judicial mistrust of limitations and exclusions
derive from? It is certainly nothing new: every law student
learns how judges since the last century have applied a rule of
construction contra proferentem so as to construe a clause of
limitation or exclusion against the interests of a person relying
on it. However, the latest contest between a court of first
instance and a higher court can perhaps be seen as the latest in a
line of contests over the power of courts to review the substantive
fairness of contracts – in this case by seeking to overturn the
effect of limitation and exclusion clauses.
Some years ago, some judges realised that there was a natural
limit to the contra proferentem rule of interpretation, since as
draftsmen got better and wording became less ambiguous, it became
harder and harder to find an interpretation that would help the
claimant circumvent the clause in question.
It may be recalled how the courts invented the doctrine of
“fundamental breach” to get around this problem. This
doctrine was to the effect that some breaches were so serious, so
fundamental, that the contract was destroyed by them, and with the
contract went any clauses of limitation or exclusion. Thus,
after a fundamental breach, there could be no question of reliance
on a limitation or exclusion clause.
There were many problems with this approach, for example, at
what point did a breach become fundamental with the effects
described above rather than just really serious? Also, what
if a party wanted to affirm the contract even after a breach that
was indubitably fundamental? According to the strict
doctrine, there would be no contract left to affirm.
In the event, the doctrine was rejected by the House of Lords in
Suisse Atlantique Société d’Armement Maritime S.A. v N.V.
Rotterdamsche Koken Centrale [1967] 1 AC 361, a case which
reaffirmed the traditional position that the court was only
concerned with interpreting contracts, albeit using canons of
construction such as contra proferentem. However, this was
not the end of the story, since the doctrine of fundamental breach
was revived by Lord Denning MR in Harbutt’s “Platicine” Ltd. V
Wayne Tank and Pump Co. Ltd [1970] 1 QB 447.
It was finally put to rest in Photo Production v Securcor Ltd
[1980] AC 827, but the history of the doctrine and the way it was
killed off are interesting for an examination and proper
understanding of Watford Electronics. In them, we can see a
contest between judges of lower courts and those of the courts
above them about how best to do “justice” in individual cases while
paying due regard to legal principle. It is this last matter
which seems most to exercise the judges who hear the appeals – and
quite rightly too. The present state of the law is nothing
short of scandalous, with lawyers quite unable to advise their
clients as to what is the best way of limiting or excluding
liabilities. Lord Wilberforce put the issue well in his
judgment in Photo Production at page 843:
"The doctrine of “fundamental breach” in spite of its
imperfections and doubtful parentage has served a useful
purpose. There was a large number of problems, productive of
injustice, in which it was worse than unsatisfactory to leave
exception clauses to operate. …. But since then Parliament has
taken a hand: it has passed the Unfair Contract Terms Act
1977. This Act applies to consumer contracts and those based
on standard terms and enables exception clauses to be applied with
regard to what is just and reasonable.”
In other words, what we are witnessing is the courts over the
course of several decades wrestling with how they can resolve a
dispute and arrive at a just conclusion, given the existence of
limitation and exclusion clauses. At times, the courts have
invented a doctrine such as fundamental breach, more recently, they
have espoused the Unfair Contract Terms Act 1977 and used that to
resolve the dilemma. What remains unresolved is what, in any
case, is the just result: only when that is resolved, can the means
to achieve the “just” result be agreed on.
There is a sense in which we can see a number of different
stages in this development:
- The early cases, where the courts simply used canons of
construction (contra proferentem) to circumvent some of the
unpleasant consequences of upholding limitation and exclusion
clauses.
- The attempt by courts of first instance and the Court of Appeal
to use the doctrine of fundamental breach as a rule of substantive
law to circumvent limitation and exclusion clauses.
- The emergence of statutory consumer-protection and other
“welfarist” statutes to protect consumers and others against the
abuse of limitation and exclusion clauses.
- The post-statutory stage, where the courts have to work out the
ambits of where they should or should not use the new powers given
to them by statute.
The most important thing to realise coming out of the Court of
Appeal’s judgment in Watford Electronics is therefore not the
immediate impact of the result – there is no doubt but that users
and suppliers will be analysing their contract terms and practices
anyway – but that it should be seen in a wider context of overall
hostility to limitations and exclusions by the courts who are
working at the coal-face of trying to achieve just results.
This requires that we should try to assess what the weaknesses are
in the Court of Appeal’s judgment, so that the possible lines of
attack on it are properly understood, for, as has been seen from
the above history, it may be safely anticipated that attempts will
be made to distinguish it, or to limit it as closely as possible to
its own facts. This will be looked at below.
First, it may be as well to look at some of the principles that
practitioners rarely consider when seeking to review laws on
limitation and exclusion clauses. What is a “just” result
when applying such laws? One’s first response, on hearing of
a user deprived of the benefits of a system for which it had
contracted, is to sympathise, to determine that proper compensation
(by which is normally meant full compensation) should be
made. Is that “just”? Maybe. However, many in the
IT industry feel an uneasiness about such a sweeping view of
“justice”. Take the facts in Watford Electronics itself:
contracts for the supply of an integrated system worth just over
£100,000 led to a contractual claim for £5.5 million. The
very grossness of the disparity must surely give rise to some
unease. Why should anyone in business undertake such serious
risks against such a minimal return?
When one looks at the books, there is surprisingly little on the
subject of limitation and exclusion clauses as such. Indeed,
the trend in modern European academic literature is rather to the
effect of promoting judicial intervention in private contracts –
the recent book by Hugh Collins “Regulating Contracts” (OUP 1999)
being a good example (see especially chapter 11 “Unfair
Contracts”). Academic literature supporting principles
derived from freedom of contract is to be found almost exclusively
in writings from the USA. Often it is said that overturning
limitations and exclusions leads to increased insurance premiums,
which leads to an inflationary rise generally: this may well be
true, but there is no readily available empirical evidence to
support this, at least in the context of IT disputes.
What support can be found for limitations and exclusions of
liability? There are probably the following arguments in
favour of upholding limitation and exclusion clauses:
1.Certainty
It is not only the parties to a contract or a dispute that want
certainty – any practising lawyer knows already that clients want
the lawyer to provide positive advice, not simply throw their hands
in the air and pronounce that the court will do whatever is
“reasonable” but no-one knows in advance what this is.
Fighting litigation in this way becomes an expensive business – the
user arguing for unlimited liability, the supplier sticking to the
contractual measure, the high stakes involved in the difference
often ensuring that litigation does not reach a compromise.
Other interested parties also want certainty – insurers of claims,
investors, a supplier’s other customers, all of whom have a vested
interest in limiting the amount of any claim against the
supplier.
2.Possible harm to other affected parties
Thus, in Pegler v Wang, the consequence of the judgment (albeit
based on a construction of the relevant clauses contra proferentem)
was that Wang went into voluntary liquidation, probably providing
an “unjust” situation not only for Pegler, but also for Wang’s
other customers for which it may have been providing a perfectly
good service.
There is the harm done by the interference in the negotiation
process – introducing the spectre of unlimited liability in fact
radically alters the balance of power in settlement
negotiations. Of course, it is true that many settlements are
in excess of the relevant contractual limitation (George Mitchell
(Chesterhall) Ltd. v Finney Lock Seeds Ltd [1983] 2 AC 803 is an
example of an industry where this happened) but the routine
overturning of such limitations potentially introduces an element
of imbalance in such negotiations.
3.Intervention is harmful to the parties
One of the results that was coming out of the use of UCTA by the
Technology and Construction Court was that users were in some cases
reluctant to negotiate limitation clauses. The reason was
simple: negotiation might take the case outside UCTA, whereas
simply taking the clause as it stood left the user with the
possibility of arguing UCTA applied and forcing the supplier to
accept unlimited liability. This radically alters the
negotiating balance between the parties and ends up with a
situation where it actually pays a user to be careless of its own
welfare.
Armed with these thoughts, it is easier to understand critically
the division in opinion between the judges of the Technology and
Construction Court and those of the Court of Appeal.
“Justice” in the TCC, following the four cases referred to at the
beginning of this comment, apparently meant giving the user an
entitlement to full compensation, regardless of whether the user
could or should have bargained for a different result in the
contract, or in fact actually did so. This is not the case
according to the Court of Appeal.
As was said above, it is also necessary to be aware of the
possible arguments that will be used to distinguish the Court of
Appeal in Watford Electronics and some comments need to be made
about this. There are probably at least three ways in which a
subsequent court will try distinguish Watford Electronics.
- The case was decided very much on its own facts and depended to
a large extent on the fact that an addendum had been specifically
negotiated which, as the Court of Appeal found, substantially
altered the thrust of the limitations and exclusions. If that
clause had not been added, the result might have been
different.
- The Court of Appeal accepted that the parties were on an equal
footing, but it only takes a little imagination for a court in a
different case to find that an IT supplier was the dominant party
and could impose its “written standard terms of business” on the
other. This happened in Pegler v Wang where one of the facts
found by the judge was to the effect that, as the parties had
started work, this gave the supplier a dominant position in
negotiations.
- If some special warning is given of “consequential” or
“indirect” losses by the user pre-contract, it may be in future
held to be unreasonable to exclude this type of loss. A
court might simply say that this type of loss was direct, not
consequential, loss.
It is this last item which is probably going to cause most
trouble. The Court of Appeal’s reasoning is a little hard to
detect. Chadwick LJ equated the limitation of liability to
the measure of damages provided by section 53(3) of the Sale of
Goods Act 1979, which is the prima facie measure of damages in the
event of delivery of goods not conforming with a warranty of
quality. This is, of course, correct but it is not the whole
story. It is only a prima facie rule and there are plenty of
exceptions to it. In particular, the cases distinguish
between situations where goods are sold for resale (in which case
the rule in section 53(3) is perfectly adequate) and those
situations where goods are sold for use. It is in this latter
situation, goods sold for use, where damages go far beyond the rule
in section 53(3). A reference to just some of the cases will
illustrate this.
In Parsons (Livestock) Ltd v Uttley Ingham & Co Ltd [1978]
QB 791 the defendants sold a hopper for storing nuts for feeding
pigs. At the time of installation, the defendants forgot to
open the top ventilator, with the result that the nuts went
mouldy. Some pigs fell ill, and the result of this was that
more pigs died from a further disease. The loss of the pigs
was worth £10,000, and the plaintiffs also claimed for loss of
profits. The claim for the loss of the pigs was allowed, but
the further claim was not allowed as being too remote. A
similar reasoning can be seen in Amstrad plc v Seagate Technology
Inc (1997) 86 BLR 34, where the defendant supplied defective hard
disk drives. The plaintiff recovered damages for lost sales
for lost and delayed sales, but not for lost sales of the
plaintiff’s following range of computers, which were allegedly
damaged by the low reputation of the plaintiff’s computers caused
by the faulty hard disk drives in the previous range as this could
not have been in the contemplation of the parties at the time of
contracting.
However, it is well established that a claim can be made for
loss of profits for the delivery and installation of a defective
machine that was intended to be profit-making. Cullinane v British Rema Manufacturing Co Ltd
[1954] 1 QB 292 is a complex case, but it seems clear at
least that it is possible to claim for the loss of profit resulting
from the delivery of a machine (for clay pulverising) that did not
comply with a contractual warranty. Such a claim would far
exceed the difference in value measure.
The result of these cases is that it is by no means clear that,
in the case of goods sold for use, the prima facie rule
contained in section 53(3) should apply. Indeed, it might
almost be said that such a rule would make no sense, since damages
in these cases are calculated on a wholly different basis.
In the case of Watford Electronics, it seems that the loss of
profits and increased costs of working could well be categorised as
direct losses, but the Court of Appeal seems to assume that these
losses would be “consequential”. See, for example, paragraph
56 of the Court of Appeal’s judgment, where Chadwick LJ said,
“The parties negotiated, also, as to
which of them should bear the risk (or the cost of insurance
against the risk) of making the loss of profits, and other
indirect or consequential loss, which Watford might suffer
if the product failed to perform as intended.”[emphasis added]
It is curious to find that loss of profits is so equated to
indirect or consequential loss. Following three cases
recently (British Sugar Plc v. NEI Power Projects Ltd (1998) 14
Const. L.J. 365; Chiemgauer Membran und Zeltbrau GmbH v New
Millennium Experience Co. Ltd, The Times 16 January 2001; and
Hilton International Hotels UK Ltd v Hotel Services Ltd (2000)
BLR 235) it is quite clear law that the expression
“consequential or indirect loss” refers to the second limb of
Hadley v Baxendale, and does not include every instance of a claim
for loss of profits (which might well be a claim for direct loss
under the first limb of Hadley v Baxendale). Chadwick LJ also
defines consequential loss as being those losses within the second
limb of Hadley v Baxendale (without citing any of the three
authorities just referred to), but there seems to be an assumption
that the majority of Watford’s claim, being for such items as loss
of profits, is to be regarded as consequential loss.
The transcripts do not give much information about the nature of
the losses claimed other than their bare descriptions.
However, it is by no means clear that Watford’s claim for loss of
profits, in circumstances where Watford informed Sanderson prior to
contract of the problems it might face, necessarily falls into the
second limb of Hadley v Baxendale rather than the
first. Indeed, it could be strongly argued that the loss of
profits and the increased costs of working were within the first
limb of Hadley v Baxendale (direct loss).
If Watford’s claim for loss of profits was treated as direct
loss, there is the outcome that liability would be limited to the
contract price (rather over £100,000), against loss of profits
claimed of £4.5 million. It would surely become harder in
that case to argue that the limit was reasonable.
There are a number of questions that every IT supplier will want
to ask and want answered definitively. For example, what is
that status of complete exclusions of liability for loss of profits
or failure to make anticipated savings? Watford Electronics
in the Court of Appeal gives no definitive answer to this
question. Nor is it authority for saying that every limit of
liability pegged to the contract price is from now on valid.
It is good authority for arguing before any court of first instance
that UCTA has no application to a situation involving parties of
equal bargaining power – and this at least must be regarded as
progress on the previous situation.
Thus, in practical terms, where does this leave IT suppliers and
procurers of IT systems? Regrettably, it will probably take
yet more litigation (including appeals) before we can tell if the
courts generally will adopt the freedom of contract approach or the
interventionist approach. This is indeed regrettable in every
sense: it is easy to see that legal fees (and all the other costs
associated with litigation) will be wasted trying to prove the
point one way or another. This is one area where certainty
could actually save costs in the long run – from either the
supplier’s or the user’s side. Unfortunately, as was seen in
the case of the doctrine of fundamental breach, it took more than
one outing in the House of Lords before that particular bogus legal
principle was laid to rest.
I can do no better than end with the words of Lord Wilberforce
in Photo Productions:
“At the judicial stage there still more
to be said for leaving cases to be decided straightforwardly on
what the parties have bargained for rather than upon analysis,
which becomes progressively more refined, of decisions in other
cases leading to inevitable appeals.” [1980] AC at 827 at
843G
From many perspectives, let us hope this view prevails.
