Facts
The Claimant company, Logistic Resources Limited (“LRL”) was a
small boutique computer software designer and developer
specialising in bespoke software systems for the insurance
industry. The key players of LRL were Mr Devonald and Mr
Shiel. The Defendant company, Eastgate Group Ltd (“Eastgate”), was
an amalgamation of companies, formed in January 1995, which
provided run-off administration services to insurance companies and
particularly to Lloyd’s syndicates. The key players of
Eastgate were Mr Hart and Mr Randall. The four individuals, Mr
Shiel, Mr Devonald, Mr Randall and Mr Hart, were friends and had
worked together before.
With one of the companies purchased by Eastgate, it acquired a
computer system called Eros, an acronym for “Electronic Run Off
System”. This was a software system which handled run-off for
individual insurance companies. This system was unsuitable for
Eastgate in two respects. It could not be used in the Lloyd’s
market without substantial enhancement as it had no facility to
process standard Lloyd’s electronic messages and it could not
process claims at a market-wide level.
Eastgate wanted a computer system similar to Eros that could be
used in the Lloyd’s market, to be known as “Eros for Lloyd’s”. This
was primarily to try to acquire run-off administration business
from a firm called Equitas. To achieve this, Eastgate needed the
system to be developed in a short timescale, by early 1996. LRL was
an obvious choice of supplier as it had developed Eros and had
relevant experience in the field. In addition, the key players of
both companies had worked together before.
Both Eastgate and LRL thought that it would be possible to
re-use part of Eros for developing Eros for Lloyd’s. LRL presented
to Eastgate a proposal for the work on 23 February 1995 (the
“February Proposal”) at a fixed price on the basis that Eros could
be re-used. Planning and analysis stages took place pursuant to an
agreement dated 27 February 1995. It transpired during these stages
that no part of Eros could be re-used. Eastgate therefore needed a
completely bespoke system to be developed by 1 January 1996.
LRL put forward a proposal dated 6 July 1995 (the “July
Proposal”) which proposed a new fixed price that was not
significantly higher than the price in the February Proposal.
The parties then entered into a new agreement on 19 July 1995 (the
“July Agreement”) to provide a completely bespoke system by January
1996 at a similar fixed price. The key issue between the parties
was whether, in return for developing the system at a low price,
LRL would become entitled to a share in the success of Eastgate’s
exploitation of the system.
Discussions took place between the parties in the summer of 1995
regarding the royalty which LRL would receive from Eastgate. Mr
Devonald’s account of these discussions was that LRL should get a
share of any success of the new system in return for only a modest
profit on the initial price of the system. Mr Hart’s was that
LRL would be entitled to a royalty in the event that Eastgate sold
or licensed the Eros for Lloyd’s software to a third party or if
Eastgate provided an IT bureau service to a third party.
Clause 4 of the July Agreement, entitled “Software Ownership”,
stated that:
“LRL undertakes to act as an agent of the
Eastgate Group in developing the Eros software and associated IPR
will remain with The Customer; except that. . . The Customer
undertakes to pay LRL not less than five per cent of income
attributable to the sale or rental or licensing of the Eros for
Lloyd’s software to any Third Party: and further undertakes to pay
LRL not less than five per cent of income attributable to the
provision of services based on the facilities comprise within the
Eros for Lloyd’s system to any Third Party. In return LRL
undertakes to provide its best endeavours in assisting The Customer
with any such sale or offering of service to a Third Party.”
A provision reserving LRL’s right to benefit from future
financial gain through making the Eros for Lloyd’s system available
to a third party had also been in the July Proposal document, under
the heading “Ownership of System.” LRL argued that the above clause
entitled them to a percentage of all income earned by Eastgate
derived from run-off administration contracts secured as a result
of the availability of Eros for Lloyd’s or performed using that
facility. LRL completed the design and development of Eros for
Lloyd’s by January 1996. After this Eastgate signed various
lucrative contracts with Equitas.
On 21 May 1998, Mr Hart sent a letter to Mr Devonald clarifying
the position regarding ongoing payments by Eastgate to LRL. He
mentioned Clause 4 of the July Agreement which stated that the
payment to LRL would be not less than 5%. He proposed that the
figure be set at 10% for any annual licence or service fees charged
by Eastgate to any external organisation. He asked Mr
Devonald to sign, date and return the attach copy of the letter to
acknowledge full agreement to the arrangements outlined in the
letter. Mr Devonald signed this letter on 26 May 1998.
There was also a letter dated 26 May 1998 from Mr Shiel to Mr
Hart. This referred to the letter of 21 May and Clause 4 of the
July Agreement. He stated that it was clearly the intention of the
parties at the time that LRL would benefit not only from the direct
use of Eros as a system by a third party, but also where services
were supplied by Eastgate, particularly run-off services, and the
use of Eros for Lloyd’s was an essential part of the services being
provided. He said that Mr Devonald had counter-signed the 21
May letter to get the invoicing underway, even though LRL did not
agree with Mr Hart’s interpretation. This second letter dated
26 March was never sent to Mr Hart but was initialled and put on
the file. It was Mr Shiel’s evidence that he did not send it
because he received certain oral assurances from Mr Hart and he
assumed that Eastgate would contract and invoice separately for
run-off and other services.
On 6 July 1999 there was a meeting between LRL and Eastgate
where Mr Devonald raised a query concerning LRL’s entitlement to a
commission on the money Eastgate was earning on its work for
Equitas. Mr Haslam of Eastgate was asked to look into the
commission arrangements. Mr Haslam e-mailed Mr Shiel in this regard
and Mr Shiel responded by letter on 17 August 1999 attaching a copy
of his letter of 26 May 1998 to Mr Hart. Of course, the 26 May
letter had never been sent to Mr Hart. Two meetings took place in
early 2000 between LRL and Eastgate to discuss all the issues
between them. Mr Shiel prepared a letter dated 10 February 2000
summarising the points discussed in which he said that all LRL’s
major concerns had now been discussed. No mention was made of an
outstanding entitlement of LRL to recover royalties from Eastgate.
The principal concern of LRL was to start work on a convergence
project which they were expecting to do for Eastgate although no
contractual commitment had been made by Eastgate. It was after
discovering that Eastgate were not going ahead with the convergence
project that LRL pursued this claim.
Judgment
Tomlinson J dismissed LRL’s claim. LRL had offered to carry out the
bespoke development work at a low price but there were clear
benefits to it doing this. If Eastgate was successful in capturing
the Equitas run-off work, there would be work converting the
syndicates’ data to make it compatible with the Eros system as well
as anticipated maintenance and updating work, enhancements to the
system and the development of additional functionality. If LRL
delivered the new system on time, it would also be good for LRL’s
reputation in the market. In actual fact, LRL earned £9.5
million from conversion work, various enhancements to the Eros
system and maintenance work.
The parties agreed that LRL would share in Eastgate’s success
with Eros for Lloyd’s: the issue was the basis on which LRL were to
share in the success and this was clearly set out in the
contractual provisions.Tomlinson J was persuaded by the fact that
future financial gain by LRL was recorded under the heading
“Software Ownership” in the July Agreement and “Ownership of
System” in the earlier July Proposal document. The thinking behind
these clauses was not that LRL would be entitled to a share in
Eastgate’s income secured from the provision of run-off
administration services through Eros, but that Eastgate’s ownership
of the IPR in the new system would prevent LRL from selling or
licensing to third parties the system which they were about to
develop. Therefore, if Eastgate chose not just to use the
system in the provision of run-off administration services but also
to make it available to others to use, then LRL should be entitled
to a share in that revenue. If the parties had intended for LRL to
share in all Eastgate’s revenue they would have expressly stated so
in the documentation.
Tomlinson J had no doubt that the men discussed LRL sharing in
any success of the Eros system and that the men discussed their
plans in ‘grandiose terms.’ However, the documents all supported
Eastgate’s case that LRL was to receive a share of profits made by
selling/licensing the product to third parties. He found ‘wholly
implausible’ LRL’s position that Eastgate would agree to give 5% of
the revenue, not the profit, to be derived from business which it
was not even certain of getting.
The judge discussed possible reasons for why Mr Shiel drafted
the 26 May letter and why he did not send it. In court, Mr
Devonald was very embarrassed about the letter. Furthermore, Mr
Shiel was on holiday between 24 and 31 May and said that he
composed the letter on his return without reference to Mr Devonald
and backdated the letter to 26 May. Tomlinson J concluded that the
letter was first drafted by Mr Shiel in August 1999 but was dated
26 May 1998 so as to give the impression that it was
contemporaneous with Mr Devonald’s acceptance of the terms of Mr
Hart’s letter and was initialled to give it the air of a copy taken
from the file.
Tomlinson J made his decision based on the facts as at the date
of the 21 May 1998 letter. He was, however, further persuaded by
the events following that, particularly the deception over Mr
Shiel’s letter of 26 May 1998 and the 2000 meetings defining the
issues between the parties where royalties were not even mentioned.
The judge’s conclusion was that this was a ‘manufactured claim.’ He
had concerns about the honesty of Mr Shiel and Mr Devonald.
Commentary
This case does not create new law, but it does serve to
highlight some of the things that go wrong when parties enter into
a software development project. By dealing with these issues
in the agreement, parties may hope to avoid the sort of dispute
that Eastgate and LRL fell into.
It is often the case that customers have existing software that
they wish to re-use, such as the Eros software in this case. There
are a number of considerations which should be made by both the
customer and the supplier before a decision is taken to develop
existing software. How economical will it be to re-use existing
software? Is there an off-the-shelf product which the customer
could buy which would be more cost effective? If the supplier has
experience of bespoke software development work in that sector, is
it quicker and cheaper for the supplier to develop the software
from scratch?
There may be commercial or political reasons why the customer
wishes existing software to be used as the basis of any development
by a supplier such as that a lot of time and money has already been
invested in the existing software. However, it is still sensible
for both the supplier and customer to consider whether using
existing software is actually the most efficient and cost effective
solution.
The supplier should proceed with caution when it prices its bid
based on the re-use of existing software. It is sensible to carry
out thorough due diligence on the system to see if it is suitable
for development and do a gap analysis to ascertain how much of the
system can be used as the basis for the new system. If it is not
possible (or economical) to carry out a thorough analysis of the
existing system pre-contract, the parties must ensure that the
contract provides for an analysis period. At the end of that
period, the parties should review whether or not the existing
product is re-usable. It is advisable to have documented a
percentage of the system beyond which the supplier will re-use the
product. For example, if 50% of the software is re-usable the
parties may decide that it should be re-used. However, if it
transpires in the analysis period that the software is only 10%
re-usable, it should be abandoned.
The contract also needs to document what happens if the parties
decide that the existing software is not re-usable. It may be that,
at the outset, the supplier has provided two prices and delivery
timetables based on re-use of existing software or developing an
entirely bespoke product. However, it is more likely that the
contract will need to provide for a period of negotiation between
the parties to address the revised deliverables, price and
timetable. It may even be that the customer wishes to have the
ability to go to a different supplier if it transpires that the
current supplier is unable to re-use the existing software.
Eastgate ran a straightforward case on the content of the
contractual documentation. LRL’s arguments relied heavily on oral
discussions and assurances made between friends which were not
documented. It is vital to ensure that an agreement is
properly documented. At the time of contracting the parties can be
full of optimism and a spirit of co-operation, but, like Eastgate
and LRL, in time they may fall out.
One area which is often not fully considered by the parties is
the ownership of IPR in the software. In relation to bespoke IT
software development projects, particularly ones where the parties
think they may be end up with a potentially lucrative and
marketable product, it is important to document which party will
own the copyright for each element of the software. Under the
Copyright, Design and Patents Act 1988, in the absence of any
contractual arrangements to the contrary, the copyright remains
with the supplier for commissioned works. If the supplier is
developing entirely bespoke software for a customer, the customer
will wish to ensure that the IPR vests in it. However, there are
other considerations. It may be that the bespoke software is
based on the supplier’s core product, in which case it would be
usual for the IPR provisions to expressly state that the supplier
owns the IPR in the core element of the system but that the
customer is entitled to the IPR in any bespoke element designed
specifically for that customer.
The parties also need to consider how the end product will be
used. If the customer owns the IPR in the software and intends to
either sell the system or make it available for third parties to
use, as Eastgate did in this case, the supplier will wish to ensure
that the contract sets out that it is entitled to a share of the
revenues generated. This is often in both parties’ interests
as they can both be involved in marketing the product. If making
the software available to third parties is a likely outcome, the
parties need to ensure that the contract clearly sets out the terms
on which the parties are to benefit. The contractual provisions may
address points such as the percentage share that the supplier is to
receive and what that share is in reference to. The customer
may wish to limit the length of time that the supplier is entitled
to receive revenue. Finally, if the parties agree to jointly market
a product, they may wish to identify categories of third parties to
whom they are prohibited from marketing the product such as direct
competitors of the customer.
The witness statements by representatives for LRL were
inconsistent and had not thoroughly addressed the issues in the
case. In addition, some of the witnesses were not able to answer
questions in relation to parts of their witness statements. Part
32.4.5 of the CPR states that a witness statement should be in the
witness’ own words and should be restricted to matters to which the
witness can readily speak if cross-examined on it. It is the role
of legal advisers to ensure that witness statements do reflect the
witness’s own words and also that the witness is knowledgeable
about the contents of his statement and able to discuss the issues
in his statement in cross-examination.
