Exclusion of liability in IT contracts

Background

IBM contracted with CISGIL (Co-Op Insurance) for the provision of IT services: namely, the implementation of a new IT system and IBM’s management of that system for 10 years. The contract price was £50.2m in respect of the supply and implementation of the new IT system and £125.6m for IBM’s management services. 

By way of brief summary, following entry into the contract, IBM sub-contracted with a third party to supply the IT software but exercised step-in rights as a consequence of the sub-contractor’s unsatisfactory performance (which led to IBM’s failure to achieve a number of important contractual milestones). IBM subsequently purported to issue an invoice to CISGIL in respect of its completion of a later milestone, but CISGIL refused to pay the invoice (owing to IBM’s prior failings). IBM consequently purported to exercise its contractual right to terminate the contract. CISGIL claimed that IBM had no right to terminate arguing that payment was not properly due, and that IBM had therefore acted in breach of contract. 

As a consequence, CISGIL brought a claim against IBM for, among other things, £128m in respect of wasted expenditure resulting from IBM’s alleged wrongful termination.

The court’s decision

In its judgment, the court determined that IBM was not entitled to terminate the contract as a result of CISGIL’s non-payment. IBM had therefore breached the contract, and it therefore fell to the court to determine whether IBM’s liability for damages had been excluded by contract.

To that end, IBM relied upon a clause which excluded liability for loss of profit, revenue and savings (including anticipated savings). This, IBM said, amounted to an exclusion of CISGIL’s claim for wasted expenditure. In contrast, CISGIL argued that a claim for wasted expenditure is not a claim for loss of profits and that its claim was therefore not excluded. In the event, the court agreed with IBM. 

The court considered that an award of damages for breach of contract should be compensatory, meaning that it ought to give effect to the parties’ contractual bargain. Any such award should therefore reflect the value of the contractual bargain of which a claimant has been deprived as a consequence of a defendant’s breach, whether that is a good bargain, resulting in profits to offset initial expenditure, or a bad one.

In this instance, the court identified that the contractual benefit lost by CISGIL was an IT solution that would improve CISGIL’s competitiveness, thereby producing savings, increased revenues and increased profits. Therefore, although CISGIL had framed its claim as one for wasted expenditure, the court held that that was simply another way of quantifying the loss: the wasted expenditure claim was by its nature the same as a claim for lost profits (which were expected by CISGIL to offset that expenditure).

It is notable that the court contrasted this case with circumstances in which an anticipated contractual benefit is non-monetary. In those circumstances, liability for loss of a contractual benefit and liability for wasted expenditure are unlikely to overlap.

Practical implications

The judgment could have wide-ranging consequences. Exclusions of liability for lost profits or savings are ubiquitous in IT contracts, and an authority suggesting that they are sufficient to exclude claims for wasted expenditure is significant. The circumstances in which this judgment arose are no doubt commonly reflected in IT contracts, in which the chief contractual benefit for a party receiving IT services will ultimately be profit-related. Commercial parties must now take extra care in negotiating and drafting such agreements, and in turn ensure those contracts properly and explicitly reflect the understanding of the parties. Particular caution should be had when considering a potential overlap in categories of loss; for the time-being it appears that the courts will focus less on the semantics of an exclusion clause and more on the fundamental nature of the loss being excluded. It is clear that limitation clauses should not be treated as boilerplate and such clauses must properly and explicitly reflect the understanding of the parties. Contractual definitions may increasingly be used to identify what is meant to be recovered under a particular head of loss. Additionally, explicit contractual remedies (for example, liquidated milestone damages or the right to recover the costs of a replacement supplier in circumstances of default) may be preferable to a party seeking services than attempts to make claims for wasted expenditure. 

It remains to be seen whether the court’s judgment will be appealed. On the one hand, it could be argued that the court has used legal (rather than commercial) principles to extend the cover afforded by IBM’s exclusion of liability clause which did not, on its face, exclude claims for wasted expenditure. On the other hand, it could be argued that CISGIL sought to unduly limit IBM’s exclusion clause by carefully framing its claim so as to make distinguish it from loss of profits on a purely superficial level. One queries how the court could possibly determine an award of damages for wasted expenditure without first considering and accounting for a claimant’s loss of profits.

Whilst cases such as these often turn on their facts and the wording of the particular clause in question, there is plainly a fresh impetus for commercial parties to reconsider these boilerplate clauses. Failure to do so may significantly hamper litigation recovery in the future. In the meantime, an effective exclusion clause for lost profits within a contract will be even more valuable to a party in default.