Compensation for failed IT projects: CIS v IBM in the Court of Appeal

Introduction

IT projects can deliver transformative benefits for businesses. Although they can involve significant commitments – both in expenditure and resource – they can also deliver fundamental changes which improve a business’ processes and functions. But what happens when they go wrong – can the disappointed party recover compensation for the benefits it did not receive, or the wasted expenditure it incurred?

The Court of Appeal decision in Sorteria Insurance Limited (formerly CIS) v IBM provides welcome guidance on the compensation payable as a result of failed IT projects. This is particularly welcome in light of the surprising first instance decision in February 2021.

Background

Large scale IT projects will always involve an element of risk. They tend to be costly and time intensive, and all too frequently there will be delay (sometimes substantial delay) against the timetable originally envisaged. However, they are also capable of delivering significant rewards to justify that risk – in the form of efficiencies, costs savings, increased profits or by way of improving the day to day experience of a business’ employees and customers.

Occasionally, those projects will fail and a business will not receive the benefits for which it contracted. Although such occasions may be much rarer, for obvious reasons failed projects tend to generate more headlines than successful ones. If the contract is terminated by the customer in a scenario where the supplier has not delivered, such that the IT solution never gets implemented, what compensation can the customer recover?

Under English law, the starting position in that situation is that a customer is entitled to recover damages to put it in the position (in so far as money can do so) that it would have been had the contract had been performed. These damages can be assessed by reference to either: (a) expectation losses or loss of bargain losses (eg the additional savings or profits that would have been generated had the solution been delivered on time); or (b) the wasted costs (eg expenditure that the customer incurred in connection with the failed project). The second basis is regarded as a proxy for the first, such that a party cannot recover more from a wasted costs claim than it could from a loss of bargain claim. It is also therefore not possible to claim both types of loss – there needs to be an election by the claiming party between the two bases of assessment. This is normally resolved in favour the one that is easiest to prove or which will result in the greatest recovery.

In practice, the recoverable compensation is normally limited by the terms of the contractual arrangements between the parties. It is increasingly common for liability for lost profits or anticipated savings to be excluded. If this is what the parties have agreed – and it is hoped that the parties will have turned their minds to this at the outset and not just accepted boiler plate exclusion clauses – then in many cases it is perfectly permissible and simply part of the bargain that the parties have made. This is particularly so where the parties are both sophisticated commercial entities, with proper resources and relatively equal bargaining power.

Prior to the first instance decision in CIS v IBM, if liability for lost profits or anticipated savings had been excluded, it was widely considered that the main form of compensation for a failed IT project was reimbursement of the wasted expenditure (the costs and time) devoted to the project. However, in CIS v IBM, the Court cast considerable doubt over whether that form of compensation would still be available where an exclusion clause was concerned with excluding lost profits, but did not expressly refer to wasted expenditure/costs.

CIS v IBM – First Instance Decision

The claim in CIS v IBM had all the classic features of an IT dispute. The project was severely delayed – by the time the contract was terminated the go live date was scheduled to take place 31 months after the original contractual completion date. It looks to have been an unhappy time for both parties, with both parties seemingly anxious to look for a way out of the predicament they were in. Things came to a head when CIS (the customer) disputed a GBP2.9m invoice raised by IBM. The invoice was not paid, and IBM terminated the contract as a result relying on a contractual right of termination which accrued where CIS failed to pay an undisputed invoice. CIS argued that IBM’s purported termination was wrongful (the right of termination had not accrued) such that CIS was entitled to terminate at common law for IBM’s repudiatory breach.

The Court was asked to decide a host of factual, technical and legal questions, but the Court ultimately held that IBM had not been entitled to terminate the contract and was therefore, in principle, liable to pay damages to CIS as compensation for the failed project.

Perhaps the most important point the Court had to decide was whether the bulk of the damages claimed by CIS relating to the wrongful termination was excluded by the terms of the contract. Of the GBP136 million claimed by CIS, about GBP120 million was for wasted expenditure arising as a result of the wrongful termination – essentially, the sums paid to IBM under the contract, financing costs and related payments made to third parties. IBM’s case was that such damages were excluded under a clause which did not expressly refer to wasted expenditure/costs, but which among other things excluded liability for “loss of profit, revenue, savings…”.

In particular, IBM argued that while the loss was assessed by reference to the expenditure that had been incurred, the actual loss was the profit, revenue or savings through which that expenditure would have later been recouped by CIS, but for the breach. CIS counter-argued that compensation for wasted expenditure would put it into a break-even position on the assumption that its financial and non-financial benefits from IBM's performance would have been worth at least as much to it as the amounts expended in reliance on the contract.

In a judgment which many saw as surprising at the time, the Court agreed with IBM that the words of the exclusion of liability clause were sufficient to exclude liability for wasted expenditure. It was particularly surprising as the same judge had reached the opposite conclusion in a similar case, involving a similar exclusion clause, 12 months previously.

This finding had a dramatic effect on CIS’ claim – although the Court recognised that CIS had suffered losses in excess of GBP100 million as a result of IBM’s wrongful termination, the Court found that its claim for wasted costs was excluded by the terms of the contract. Instead, CIS’ consolation was to recover GBP16 million from IBM for pre-termination losses, although even that was reduced by the value of unpaid GBP2.9 million invoice which had triggered the termination.

Perhaps unsurprisingly, CIS appealed the decision to the Court of Appeal.

Court of Appeal decision

In a unanimous decision, the three Court of Appeal judges overturned the first instance judgment and held that the exclusion clause did not exclude liability for wasted expenditure. A number of reasons were given to support the Court of Appeal’s findings, but for those involved in contracting for IT projects the most important were as follows:

1. Different type of loss – the Court of Appeal held that, as a matter of law, wasted expenditure is a different type of loss from lost profits, revenue or savings. The latter amount to forward looking, speculative losses – they compensate for the benefits that would have been obtained in the future. In contrast, wasted expenditure is not at all speculative. Such a claim looks backwards to the actual costs incurred, with no need to speculate on what would have happened in the alternative world where the contract had been performed. This finding meant that a clause excluding lost profits, revenue or savings could not also exclude wasted expenditure;
2. Natural language of the words used – when ascertaining the meaning of a contract, the starting point is always the natural meaning of the words used. Here, the exclusion clause simply made no reference to wasted expenditure. As such, having found that lost profits, revenue or savings was not the same type of loss as wasted expenditure, there was no language which could be identified in the clause to exclude liability for wasted expenditure; and
3. Interpreting exclusion clauses – there is a general principle that, when assessing the meaning of language in an exclusion clause, the Court will expect to see clear language to exclude remedies which would otherwise be available. The more valuable the right, the more inherently unlikely it will be that a party would have agreed to give up that right. Accordingly, the Courts will be slow to find that parties have given up very valuable rights in the absence of clear, unambiguous wording to that effect.

There is an obvious logic to the Court of Appeal’s reasoning. If a customer spends GBP100 million on an IT system, one would expect that the customer would want to get its money back if the system is never delivered. Hypothetically, there could be circumstances in which the customer might agree to forfeit that right, but one would expect to see that spelt out in clear and express terms. That represents a much more logical, and commercial, outcome than the customer losing that right because it agreed to forfeit its right to recover damages for loss of profits or savings.

Conclusion

The Court of Appeal’s clarification is likely to be largely welcomed by customers and suppliers alike. It emphasises that it is for the parties, when putting their contracts in place, to agree what will or will not be recoverable, and to spell that out in clear and unambiguous terms. If the parties to do so, then the Courts will be slow to interfere with the bargain that the parties have made.