In the opening paragraph of his judgment in Soteria Insurance Ltd (formerly CIS General Insurance Ltd) v IBM United Kingdom Ltd , Coulson LJ remarked that at least £80 million turned on the construction of one clause in the contract between the parties. That clause was an exclusion clause which sought to exclude liability for, amongst other things, “loss of profit, revenue, savings”. The Court of Appeal had to decide whether to uphold the first instance decision that the clause excluded IBM’s liability for wasted expenditure.
CIS entered a contract with IBM to implement a new IT system for its insurance business. The project did not go to plan and there were serious delays. IBM purported to terminate the contract following CIS’ failure to pay an invoice. CIS argued that termination was wrongful and treated it as a repudiatory breach of contract. CIS sought damages for wrongful termination including some £132 million in respect of wasted expenditure.
At first instance O’Farrell J found the contract had been wrongfully terminated but that an exclusion clause in the contract excluded the claim for wasted expenditure in its entirety. You can read our previous article herefor more information about the first instance decision.
The clause in question, clause 23.3 stated:
“…neither party shall be liable to the other or any third party for any Losses arising under and/or in connection with this Agreement…which are indirect or consequential Losses, or for loss of profit, revenue and savings (including anticipated savings)…”
CIS appealed the decision. There were a number of issues addressed by the Court of Appeal but this article focuses solely on the question of construction of the exclusion clause.
The Court of Appeal’s decision
Coulson LJ highlighted five reasons why he considered that O’Farrell’s construction of clause 23.3 was wrong.
- Firstly, he considered the judge had not looked at the natural and ordinary meaning of the words in the clause. He stated that claims for “wasted expenditure” were not excluded because “those were words are simply not there.” The objective meaning of the words “loss of profit, revenue [or] savings” did not include “wasted expenditure”. The clause went into detail about what types of losses were excluded but did not mention “wasted expenditure” which the judge found to be “telling.”
- He looked at the proper approach to exclusion clauses and stressed that the more valuable the right being excluded, the clearer the language of any exclusion clause needs to be. He found that the parties could not be taken to have excluded wasted expenditure, which was an obvious and common type of damages, when they had not made any reference to it in the clause.
- Loss of profits, revenues and savings can be distinguished from wasted expenditure. The former are difficult to be estimated in advance and difficult to prove. There is therefore a reason why those claims are routinely excluded. Wasted expenditure on the other hand is easy to ascertain. The claimant will have incurred expenditure for which they will have receipts, invoices etc. Coulson LJ found it made commercial sense to exclude uncertain types of loss but not easily ascertainable loss. As he put it “The claims that would have compensated [CIS] from being better off as a result of the new IT system were excluded; the claims to compensate them for being worse off as a result of the non-provision of the IT system were not.”
- Next Coulson LJ considered what the loss of bargain was. IBM suggested that the sole loss of bargain was the savings, revenues and profit that would have been achieved from a successful implementation. He disagreed with this analysis instead finding that the primary thing that was lost was the provision of a new improved IT system. The contract excluded positive interests but did not exclude negative interests, namely “expenses incurred and losses suffered in reliance on the contract”.
- Lastly, Coulson LJ considered an argument which had found favour with the judge as well as O’Farrell’s previous judgment in the case of Royal Devon v ATOS. The argument was that a claim for damages for repudiatory breach would usually be for savings/revenue/profits had the contract been performed. Wasted expenditure would be presumed to be recouped from the profit, revenue or savings (although that was a rebuttable presumption). As clause 23.3 excluded loss of profit etc, it also excluded any claim for wasted expenditure. Coulson J stated that the characterisation of wasted expenditure as a method of calculating loss of profits etc was an “unjustified leap in reasoning”. In the Royal Devon case the judge had found that a similar clause to clause 23.3 did not exclude liability because the claimant health authority had lost a non-pecuniary benefit. Coulson LJ disagreed that the position should be any different when a pecuniary benefit had been lost.
The Court of Appeal therefore concluded that the judge had been wrong on the construction issue and had not followed the applicable principles. The appeal was therefore allowed and recovery of damages for wasted expenditure was not excluded by clause 23.3.
What to watch out for
Exclusion clauses of this nature are commonplace in many IT projects. The decision will no doubt come as a relief to companies who faced the prospect of not being able to recover their wasted expenditure if their IT projects fail.
For IT companies the decision highlights the need for clarity in the drafting of exclusion clauses and the inclusion of specific wording. For those who want to seek to exclude liability the judgment emphasises that the more valuable the right being excluded, the clearer the language of the exclusion clause needs to be.