Out-Law Guide | 09 Sep 2011 | 3:09 pm | 8 min. read
British Gas and Accenture entered into an agreement on 28 January 2002 pursuant to which Accenture agreed to design, supply, install and maintain a new IT system (the "Jupiter System") for British Gas, including an automated billing system based on pre-packaged SAP software (the "Agreement" – as subsequently amended by the parties). The Jupiter System was due to be delivered in five releases, the third of which was to be the billing system.
Substantial disputes had arisen over the performance of the first two deliverables, but these were settled in July 2004 on terms that Accenture would complete a pilot release of the billing system (Release 3B), but that application migration and maintenance would then be assumed by British Gas' in-house team. The last two releases were also suspended.
Problems with the billing system began to emerge in around June 2006. Increasing numbers of customer accounts were going unbilled and customer satisfaction was decreasing. British Gas claimed that the system created so many "exceptions" (18 million) that it had to hire thousands of staff to manually deal with the billing backlog. Consequently, a vast number of British Gas customer accounts were not billing correctly, resulting in decreased customer satisfaction.
In February 2007, and pursuant to clause 15.4.3 of the Agreement, British Gas notified Accenture of certain Fundamental Defects (as defined in the Agreement and discussed below) in the billing system (the "Notification Letter"). Accenture r fused to take any remedial steps, instead asserting that there were no Fundamental Defects in relation to the billing system and that British Gas' Notification Letter was ineffective to trigger its obligations under the Agreement.
As a result, British Gas commenced proceedings against Accenture asserting breaches of warranties as to the performance and functionality of the third release. Specifically, British Gas claimed that there were six fundamental breaches of warranty, each of which caused a severe adverse effect on the British Gas business such that each constituted a Fundamental Defect. British Gas also pleaded in the alternative that the six fundamental breaches of warranty combined to cause a severe adverse effect on the British Gas business such that there were one or more Fundamental Defects. Accenture defended, arguing that the individual breaches of warranty could not be combined for the purpose of establishing a fundamental breach or for the purpose of establishing a Fundamental Defect.
The High Court was asked (by order of Mr Justice Burton) to determine a number of preliminary issues (accordingly, no final findings of fact have been made in the case), including:
Interpreting what breaches could amount to a Fundamental Defect under the Agreement; and
Whether the losses claimed were excluded under the terms of the Agreement.
British Gas claimed the following losses:
£18.7 million for gas distribution charges on the basis that it was charged for gas on an estimated consumption rather than actual consumption basis as the gas distributors were not provided with meter date for 15% of the customers;
£8 million for ex gratia compensation payments to its customers for the billing difficulties and poor customer service;
£2 million in additional borrowing charges due to late billing or non-billing of customers; and
Other sums incurred in chasing debts, additional stationery and correspondence costs.
Fundamental and Material Defects
The Agreement drew a distinction between:
(a) Fundamental Defects: a fundamental breach of warranty which causes a severe adverse effect on British Gas' business; and
(b) Material Defects: a breach of warranty which has or is likely to have an adverse effect on British Gas' business.
The distinction was important as the level of effort which had to be exercised differed depending on whether British Gas notified Accenture of a Fundamental or Material Defect.
British Gas' Remedy - Clause 15.4.3
Upon notification of a Fundamental Defect, Accenture was obliged to do what a commercial, reasonable and prudent organisation using the system to carry on its business would do when acting in its own best interests (having due regard to the costs necessary and benefits likely from correcting the Fundamental Defect). Under the Agreement, this was British Gas' sole and exclusive remedy unless Accenture failed to use its prompt endeavours to correct the breach.
Exclusion of Loss – Clause 16.2
The Agreement excluded both parties' liability for the following types of loss:
(a) Loss of profits or of contracts arising directly or indirectly;
(b) Loss of business or revenues arising directly or indirectly; and
(c) Losses or damages to the extent that they are indirect or consequential or punitive.
The High Court (Mr Justice Field) found largely in favour of British Gas, holding that the following losses were direct losses (falling within the first limb of the test in Hadley v Baxendale (1854) 9 Ex. 341: i.e. arising naturally and in the ordinary course of things) and, therefore, in principle recoverable by British Gas from Accenture in the main dispute:
Compensation payments (£8 million): in the context of the Agreement and the commercial background, it was clear that the new system was intended (amongst other things) to improve customer relations and services. Although Accenture argued that it had not assumed responsibility to British Gas for this loss, the Court decided that it was plain in the context of the Agreement that it had assumed responsibility for losses in relation to customer compensation if the system failed to perform as contracted for.
Gas distribution charges (approximately £18.7 million): Accenture argued that this was indirect loss arising out of British Gas' contracts with third parties which were outside of its knowledge. The Court held that this was direct loss which did not arise out of special contracts with suppliers.
Additional borrowing charges (£2 million): once again, the Court held that this was direct loss. The allegedly defective billing system was at the core of British Gas' business and a very likely consequence of any breach would be additional borrowings to make up for loss of revenues.
Cost of chasing debt not due and additional stationery and correspondence costs (approximately (£500,000): Court decided that these items once again amounted to direct losses).
The High Court also held that a Fundamental Defect could be constituted by individual breaches of warranty. The consequences of the individual breaches could then be aggregated to decide whether there had been a serious adverse effect on British Gas' business.
Accenture appealed Mr Justice Field's decision to the Court of Appeal.
The Court of Appeal upheld the High Court's judgment that all of the losses identified above amounted to direct losses. The CA held that Accenture's argument that it had not assumed responsibility (following the Transfield Shipping case ) for ex gratia compensation payments did not fall within the question of whether or not this type of loss was excluded by the operation of clause 16.2 of the Agreement. As such, it has been left open for Accenture to raise this argument at full trial of the dispute.
The Court of Appeal also endorsed the High Court's approach to the aggregation of individual breaches of warranty in order to constitute a Fundamental Defect.
One of the most interesting aspects of the case is the approach taken by both Courts to the interpretation of clause 16.2 (exclusion of loss). In reaching its decision on whether the losses claimed by British Gas were direct or indirect, the High Court applied the rule set out in Hadley v Baxendale. The rule provides that those losses which may fairly and reasonably be considered as arising naturally from the breach of contract (i.e. according to the usual course of things) are considered to be direct losses, whereas losses which may reasonably be supposed to have been in the contemplation of the parties at the time of contract formation are considered to be indirect losses. The Court found that all of the losses claimed by British Gas fell within the first limb of the rule and were, in principle, recoverable by British Gas under the Agreement. If the Agreement had, for example, been on Accenture's standard terms of conditions and the parties had been of unequal bargaining strength, British Gas may have advanced an alternative argument that the exclusion clause failed to satisfy the test of reasonableness under Unfair Contract Terms Act 1977 ("UCTA").
UCTA states that in order to be valid and enforceable, a term which purports to exclude or restrict liability for breach of contract is enforceable only to the extent that it satisfies the reasonableness test. In answering this question, the Court will have regard to the circumstances which were, or ought reasonably to have been known, to the parties at time of contractual formation. However, in the British Gas v Accenture case there was no question of inequality of bargaining strength and the Agreement was not on Accenture's standard terms and conditions.
Consequently, UCTA would not have applied on the facts. The only way that the Court could provide a means for British Gas to (in principle) recover its losses was by categorising them as direct losses. From a supplier's perspective, the decision may seem a little unforgiving. In particular, the categorisation of ex gratia customer compensation payments as direct loss could be seen as a broadening of the meaning of direct loss. British Gas' decision to compensate its customers was clearly a commercial decision taken at risk to ameliorate the damage caused by the problems with the newly installed billing system. As such, the Court's approach could be seen by suppliers as an overly generous interpretation of the meaning of direct loss which did not reflect commercial realities, particularly given the commercial basis for British Gas' decision to pay out this money. Nevertheless, it is clear that the unique facts of the case, including the benefits which were intended to inure to British Gas following the installation of the new billing system, were material to the High Court's decision. It is, therefore, unclear whether the interpretation of direct loss in subsequent cases will be quite so generous to customers or whether the case marks a shift in battle ground from framing challenges to exclusion clauses under the UCTA regime to arguments centred on the interpretation of what constitutes direct loss.
In addition, for suppliers of software systems and outsourcing services, the case may be of great significance for the Court's customer-friendly approach to identifying the factual matrix against which the contract ought to be construed. The case emphasises that an agreement shall be interpreted by the Court in its commercial context. Interpretation of the clause in question should follow the approach taken by Lord Hoffman in ICS v West Bromwich Building Society: the meaning which the agreement would convey to a reasonable person with all the background knowledge (the "matrix of fact") which would reasonably have been available at the time that the contract was entered into. As for the admissible background or matrix of fact, Lord Hoffman stated that subject to the requirement that it should have been reasonably available to the parties, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.
In the British Gas v Accenture case, it was clear to both parties that the new system was intended to replace British Gas' entire billing system and would administer the accounts of over 16 million people and was therefore of crucial importance to British Gas. Any significant defects were, therefore, very likely to have a serious adverse effect on British Gas' business.