Being prepared for potential restrictions on tech claims

Navigating Technology Disputes: Get IT right!

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Introduction

Businesses are sometimes unaware of the standard restrictions that might apply to a claim they wish to bring under a technology contract. In this third article in our series about issues which might impact on technology disputes, we consider some of the more common restrictions.

Entire agreement clauses

An entire agreement clause seeks to ensure that the written terms in the agreement are the only contractual terms which exist between the parties, where the law will allow, and to stop a party from seeking to rely on any other statement or representation made outside of the contract.

The first step in any contractual claim is to identify the specific obligation(s) that have been breached. That is straightforward if the obligation is expressly written into the contract. However, there are circumstances where statements that are not expressly recorded in the contract can still form the basis of a claim. That often fits with the parties’ commercial expectations that the other party is true to its word, whether or not it is enshrined in the agreement. In some cases, the law can find that an actionable misrepresentation has occurred. In other cases, it might be necessary to bridge a gap in the drafting of the contract to make an agreement work in practical terms, in which case a court may be persuaded to imply a term that has not been expressly recorded in the agreement. There are also other circumstances where parties might be found to have reached a separate free-standing agreement to the written agreement; a collateral warranty or contract.

Those extraneous elements may be considered to cut across one of the principle purposes of a written contract, which is to achieve certainty as to the legal terms that apply to the parties’ relationship. To that end, Mr. Justice Lightman put it best in Inntrepeneur Pub Co v East Crown: entire agreement clauses are intended to prevent a party “from thrashing through the undergrowth and finding, in the course of negotiations, some (chance) remark or statement (often long-forgotten or difficult to recall or explain) upon which to found a claim.

Entire agreement clauses are particularly significant in technology contracts, which are generally concluded following lengthy and complex negotiations between operational specialists and often after an extensive tender process.

Where there is an entire agreement clause, it reinforces the importance of recording in the contract, so far as possible, the technical specifications on which the contract is founded. In bespoke contracts that is often done by scheduling agreed documentation, e.g. contract plans and specifications, to the back of the written agreement – even where the detail of those documents might be painstakingly extensive (it is not uncommon for compact discs or media files to be scheduled where their content would be too unwieldy to print…).

Entire agreement clauses are, however, not always effective to exclude written or oral communications outside of the contract being relied upon as the basis of a claim – that will turn on the wording of the clause in question and the nature of the communication concerned.

Common law restrictions

In a claim for breach of contract, the default rule is that an aggrieved party should be placed in the same situation, as far as a payment of monetary damages can achieve it, as if the contract had been properly and fully performed. In other words, the damages are intended to compensate for actual performance of the contract. That maxim is subject to some important restrictions under the general law (i.e. restrictions that are not necessarily expressly referred to in the parties’ contract).

The rule on remoteness

A loss cannot be recovered if it is considered to be too remote. The types of losses which are, in theory, recoverable fall into two categories: (i) direct loss (i.e. those natural results of the breach, which for example are usually considered to include the lost profits that a business might otherwise have made in its ordinary course of dealing); and (ii) indirect loss (i.e. those that arise from a special or unique circumstance in that case).

Subject to other contractual provisions (e.g. exclusion or limitation of liability clauses, on which see below) both types of loss would generally be recoverable as matter of law. However, it is common for parties to treat direct losses and indirect losses differently, with the direct losses being recoverable, but indirect losses not so. In addition, even if not excluded, indirect losses will only be recoverable in circumstances where the breaching party was made aware of the potential for that type of loss at the time of contracting. That puts more emphasis on the parties’ discussions when negotiating the contractual terms at the outset.

The general message is that: if, as a customer, you are bringing in a technology solution to service a particularly significant, or atypical client or business need, you should give the supplier notice of that from the very beginning (in as clear terms as possible). Conversely, technology providers should be alert to any such notifications made in discussions between the parties at the outset and consider what other contractual provisions might protect their position in the event of their breach.

The rule on mitigation of loss

Another common law rule is that an aggrieved party is under a duty to mitigate its loss. That means that a party cannot claim for losses which arise from a breach that can still be avoided by taking reasonable steps. It is, however, possible to recover the costs incurred in the steps taken to avoid the loss. That party is not expected to go further than it would in the ordinary course of business, indeed what is required of it is not a particularly high bar to meet, given that it is the other party to the contract that is in breach. So, for example, where a supplier fails to provide a software package on time, the customer may be expected to obtain a similar package if one is available elsewhere (or otherwise not take unreasonable steps to service its needs in the short term). That is, as opposed to bringing a bigger claim for loss of business caused by not having the use of the software (though one would hope that such an approach would in any event make common business sense). Any additional expense the customer reasonably incurs in seeking to mitigate its loss should be recoverable.

Liquidated damages and service credits

A technology contract will often restrict the amount payable as damages in response to a particular kind of breach by reference to a scheme which awards service credits for sub-standard performance. Those clauses usually respond to the most predictable possible adverse outcomes: e.g. late delivery or failure to achieve a specified volume. Certain contracts will include provisions which state that in the event of such a breach, service credits are the aggrieved party’s only remedy, elevating the importance of those clauses.

Service credits are a type of liquidated damages clause; i.e. where the parties try to establish a defined sum payable in response to a possible future breach. They are enforceable and need to be distinguished from penalty clauses which are unenforceable. The leading cases on distinguishing penalty clauses from liquidated damages are Cavendish Square Holding BV v Makdessi and Parking Eye Ltd v Beavis (heard together), which determine a liquidated damages clause will not be a penalty if:

  • the party to whom the sum is payable had a legitimate interest in ensuring performance by the other party; and
  • the sum payable is not extravagant or unconscionable in order to protect that interest.

The test does not strictly confine the parties; recent case law has suggested that a clause can have a very harsh outcome financially, but still be enforceable.

When confronted with the prospect of a service credit liability, the parties must consider whether it is enforceable by applying the test noted above. That is particularly key where service credits are intended to be an exclusive remedy for the breach. However, if the clause is struck down, common law principles as to claiming damages will still apply, subject to the need to prove the loss and any other restrictions in the contract and at common law. For those reasons, it may be in the interest of the wrongdoer not to challenge the validity of such a clause, if the outcome is less painful financially than the common law alternatives.

Exclusion and limitation of liability clauses

A party to a contract will often seek to limit the amount payable in respect of a claim (say, by reference to sums received by the supplier under the contract over a particular period, thereby limiting its liability to its potential gross income from the deal) or by excluding liability in response to certain types of loss, for example: any loss of profits; damage to reputation or goodwill; or wasted expenditure, in the event that the project is affected by unforeseen delays.

The enforceability of those clauses can have a huge impact on what damages can be recovered and are therefore heavily litigated. They are also frequently drafted in such a way that their meaning and intended reach is not always clear. For example, in CIS General Insurance Ltd v IBM United Kingdom Ltd, Mrs. Justice O’Farrell determined that a claim by CIS for £128 million by way of wasted expenditure was barred by a clause that excluded any claim by either party for “loss of profit, revenue, savings (including anticipated savings)…(in all cases whether direct or indirect)”. That is to be contrasted with the earlier decision in the Royal Devon and Exeter NHS Foundation Trust case, where an exclusion of liability provision which stated: “neither party shall be liable to the other for: (i) loss of profits, or of business, or of revenue, or of goodwill, or of anticipated savings; and/or (ii) indirect or consequential loss or damage” was held not to bar the Trust’s claim for wasted expenditure (on the basis that, unlike CIS, the Trust’s loss was a “non-pecuniary benefit that was not caught by the exclusion). The different outcomes in those two judgments are a reminder that, where a breach gives rise to a significant consequential liability like lost profits, reputational damage, or sunk costs, any provision seeking to exclude liability for that loss must be closely examined against the background of a volume of case law.

It is also worth noting that, in certain circumstances, limitations on (and exclusions of) liability are also subject to a reasonableness test under Schedule 2 of the Unfair Contract Terms Act. Whilst that test can apply to bespoke, negotiated contracts for certain provisions, it has a wider scope when a party deals on its standard terms of business. Should a claim be affected by a limitation or exclusion clause, consideration should always be given to the application of the reasonableness test.

Conclusion

As this article suggests, formulating a claim where a breach has arisen is by no means a straightforward exercise. The above represents a whistle-stop tour through some of the more common restrictions and is intended to provide an insight into the more prevalent considerations when assessing what may or may not be recoverable following a breach (and what steps should be taken by the claimant in anticipation of bringing a claim). The above should also assist at the outset of any contract being entered into; a guide of what to watch out for when a potentially adverse outcome should be taken into account.