Logistic Resources v Eastgate

Out-Law Guide | 02 Nov 2007 | 8:31 am | 12 min. read

This case highlights the need for clear and unambiguous agreements as to how parties will share in the fruits of software which is developed for one purpose but may prove marketable to third parties.

Logistic Resources Limited v Eastgate Group Limited

  • MCLR April 2003
  • [2002] EWHC 1229 (Comm)
  • [2002] All ER (D) 132 (Jun)

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Facts

The Claimant company, Logistic Resources Limited (“LRL”) was a small boutique computer software designer and developer specialising in bespoke software systems for the insurance industry.  The key players of LRL were Mr Devonald and Mr Shiel. The Defendant company, Eastgate Group Ltd (“Eastgate”), was an amalgamation of companies, formed in January 1995, which provided run-off administration services to insurance companies and particularly to Lloyd’s syndicates.  The key players of Eastgate were Mr Hart and Mr Randall. The four individuals, Mr Shiel, Mr Devonald, Mr Randall and Mr Hart, were friends and had worked together before.

With one of the companies purchased by Eastgate, it acquired a computer system called Eros, an acronym for “Electronic Run Off System”. This was a software system which handled run-off for individual insurance companies. This system was unsuitable for Eastgate in two respects. It could not be used in the Lloyd’s market without substantial enhancement as it had no facility to process standard Lloyd’s electronic messages and it could not process claims at a market-wide level.

Eastgate wanted a computer system similar to Eros that could be used in the Lloyd’s market, to be known as “Eros for Lloyd’s”. This was primarily to try to acquire run-off administration business from a firm called Equitas. To achieve this, Eastgate needed the system to be developed in a short timescale, by early 1996. LRL was an obvious choice of supplier as it had developed Eros and had relevant experience in the field. In addition, the key players of both companies had worked together before.

Both Eastgate and LRL thought that it would be possible to re-use part of Eros for developing Eros for Lloyd’s. LRL presented to Eastgate a proposal for the work on 23 February 1995 (the “February Proposal”) at a fixed price on the basis that Eros could be re-used. Planning and analysis stages took place pursuant to an agreement dated 27 February 1995. It transpired during these stages that no part of Eros could be re-used. Eastgate therefore needed a completely bespoke system to be developed by 1 January 1996.

LRL put forward a proposal dated 6 July 1995 (the “July Proposal”) which proposed a new fixed price that was not significantly higher than the price in the February Proposal.  The parties then entered into a new agreement on 19 July 1995 (the “July Agreement”) to provide a completely bespoke system by January 1996 at a similar fixed price. The key issue between the parties was whether, in return for developing the system at a low price, LRL would become entitled to a share in the success of Eastgate’s exploitation of the system.

Discussions took place between the parties in the summer of 1995 regarding the royalty which LRL would receive from Eastgate. Mr Devonald’s account of these discussions was that LRL should get a share of any success of the new system in return for only a modest profit on the initial price of the system.  Mr Hart’s was that LRL would be entitled to a royalty in the event that Eastgate sold or licensed the Eros for Lloyd’s software to a third party or if Eastgate provided an IT bureau service to a third party.

Clause 4 of the July Agreement, entitled “Software Ownership”, stated that:

“LRL undertakes to act as an agent of the Eastgate Group in developing the Eros software and associated IPR will remain with The Customer; except that. . . The Customer undertakes to pay LRL not less than five per cent of income attributable to the sale or rental or licensing of the Eros for Lloyd’s software to any Third Party: and further undertakes to pay LRL not less than five per cent of income attributable to the provision of services based on the facilities comprise within the Eros for Lloyd’s system to any Third Party. In return LRL undertakes to provide its best endeavours in assisting The Customer with any such sale or offering of service to a Third Party.”

A provision reserving LRL’s right to benefit from future financial gain through making the Eros for Lloyd’s system available to a third party had also been in the July Proposal document, under the heading “Ownership of System.” LRL argued that the above clause entitled them to a percentage of all income earned by Eastgate derived from run-off administration contracts secured as a result of the availability of Eros for Lloyd’s or performed using that facility. LRL completed the design and development of Eros for Lloyd’s by January 1996.  After this Eastgate signed various lucrative contracts with Equitas.

On 21 May 1998, Mr Hart sent a letter to Mr Devonald clarifying the position regarding ongoing payments by Eastgate to LRL. He mentioned Clause 4 of the July Agreement which stated that the payment to LRL would be not less than 5%. He proposed that the figure be set at 10% for any annual licence or service fees charged by Eastgate to any external organisation.  He asked Mr Devonald to sign, date and return the attach copy of the letter to acknowledge full agreement to the arrangements outlined in the letter. Mr Devonald signed this letter on 26 May 1998.

There was also a letter dated 26 May 1998 from Mr Shiel to Mr Hart. This referred to the letter of 21 May and Clause 4 of the July Agreement. He stated that it was clearly the intention of the parties at the time that LRL would benefit not only from the direct use of Eros as a system by a third party, but also where services were supplied by Eastgate, particularly run-off services, and the use of Eros for Lloyd’s was an essential part of the services being provided.  He said that Mr Devonald had counter-signed the 21 May letter to get the invoicing underway, even though LRL did not agree with Mr Hart’s interpretation.  This second letter dated 26 March was never sent to Mr Hart but was initialled and put on the file. It was Mr Shiel’s evidence that he did not send it because he received certain oral assurances from Mr Hart and he assumed that Eastgate would contract and invoice separately for run-off and other services.

On 6 July 1999 there was a meeting between LRL and Eastgate where Mr Devonald raised a query concerning LRL’s entitlement to a commission on the money Eastgate was earning on its work for Equitas. Mr Haslam of Eastgate was asked to look into the commission arrangements. Mr Haslam e-mailed Mr Shiel in this regard and Mr Shiel responded by letter on 17 August 1999 attaching a copy of his letter of 26 May 1998 to Mr Hart. Of course, the 26 May letter had never been sent to Mr Hart. Two meetings took place in early 2000 between LRL and Eastgate to discuss all the issues between them. Mr Shiel prepared a letter dated 10 February 2000 summarising the points discussed in which he said that all LRL’s major concerns had now been discussed. No mention was made of an outstanding entitlement of LRL to recover royalties from Eastgate. The principal concern of LRL was to start work on a convergence project which they were expecting to do for Eastgate although no contractual commitment had been made by Eastgate. It was after discovering that Eastgate were not going ahead with the convergence project that LRL pursued this claim.

Judgment

Tomlinson J dismissed LRL’s claim. LRL had offered to carry out the bespoke development work at a low price but there were clear benefits to it doing this. If Eastgate was successful in capturing the Equitas run-off work, there would be work converting the syndicates’ data to make it compatible with the Eros system as well as anticipated maintenance and updating work, enhancements to the system and the development of additional functionality. If LRL delivered the new system on time, it would also be good for LRL’s reputation in the market.  In actual fact, LRL earned £9.5 million from conversion work, various enhancements to the Eros system and maintenance work.

The parties agreed that LRL would share in Eastgate’s success with Eros for Lloyd’s: the issue was the basis on which LRL were to share in the success and this was clearly set out in the contractual provisions.Tomlinson J was persuaded by the fact that future financial gain by LRL was recorded under the heading “Software Ownership” in the July Agreement and “Ownership of System” in the earlier July Proposal document. The thinking behind these clauses was not that LRL would be entitled to a share in Eastgate’s income secured from the provision of run-off administration services through Eros, but that Eastgate’s ownership of the IPR in the new system would prevent LRL from selling or licensing to third parties the system which they were about to develop.  Therefore, if Eastgate chose not just to use the system in the provision of run-off administration services but also to make it available to others to use, then LRL should be entitled to a share in that revenue. If the parties had intended for LRL to share in all Eastgate’s revenue they would have expressly stated so in the documentation.

Tomlinson J had no doubt that the men discussed LRL sharing in any success of the Eros system and that the men discussed their plans in ‘grandiose terms.’ However, the documents all supported Eastgate’s case that LRL was to receive a share of profits made by selling/licensing the product to third parties. He found ‘wholly implausible’ LRL’s position that Eastgate would agree to give 5% of the revenue, not the profit, to be derived from business which it was not even certain of getting.

The judge discussed possible reasons for why Mr Shiel drafted the 26 May letter and why he did not send it.  In court, Mr Devonald was very embarrassed about the letter. Furthermore, Mr Shiel was on holiday between 24 and 31 May and said that he composed the letter on his return without reference to Mr Devonald and backdated the letter to 26 May. Tomlinson J concluded that the letter was first drafted by Mr Shiel in August 1999 but was dated 26 May 1998 so as to give the impression that it was contemporaneous with Mr Devonald’s acceptance of the terms of Mr Hart’s letter and was initialled to give it the air of a copy taken from the file.

Tomlinson J made his decision based on the facts as at the date of the 21 May 1998 letter. He was, however, further persuaded by the events following that, particularly the deception over Mr Shiel’s letter of 26 May 1998 and the 2000 meetings defining the issues between the parties where royalties were not even mentioned. The judge’s conclusion was that this was a ‘manufactured claim.’ He had concerns about the honesty of Mr Shiel and Mr Devonald.

Commentary

This case does not create new law, but it does serve to highlight some of the things that go wrong when parties enter into a software development project.  By dealing with these issues in the agreement, parties may hope to avoid the sort of dispute that Eastgate and LRL fell into.

It is often the case that customers have existing software that they wish to re-use, such as the Eros software in this case. There are a number of considerations which should be made by both the customer and the supplier before a decision is taken to develop existing software. How economical will it be to re-use existing software? Is there an off-the-shelf product which the customer could buy which would be more cost effective? If the supplier has experience of bespoke software development work in that sector, is it quicker and cheaper for the supplier to develop the software from scratch?

There may be commercial or political reasons why the customer wishes existing software to be used as the basis of any development by a supplier such as that a lot of time and money has already been invested in the existing software. However, it is still sensible for both the supplier and customer to consider whether using existing software is actually the most efficient and cost effective solution.

The supplier should proceed with caution when it prices its bid based on the re-use of existing software. It is sensible to carry out thorough due diligence on the system to see if it is suitable for development and do a gap analysis to ascertain how much of the system can be used as the basis for the new system. If it is not possible (or economical) to carry out a thorough analysis of the existing system pre-contract, the parties must ensure that the contract provides for an analysis period. At the end of that period, the parties should review whether or not the existing product is re-usable. It is advisable to have documented a percentage of the system beyond which the supplier will re-use the product. For example, if 50% of the software is re-usable the parties may decide that it should be re-used. However, if it transpires in the analysis period that the software is only 10% re-usable, it should be abandoned.

The contract also needs to document what happens if the parties decide that the existing software is not re-usable. It may be that, at the outset, the supplier has provided two prices and delivery timetables based on re-use of existing software or developing an entirely bespoke product. However, it is more likely that the contract will need to provide for a period of negotiation between the parties to address the revised deliverables, price and timetable. It may even be that the customer wishes to have the ability to go to a different supplier if it transpires that the current supplier is unable to re-use the existing software.

Eastgate ran a straightforward case on the content of the contractual documentation. LRL’s arguments relied heavily on oral discussions and assurances made between friends which were not documented.  It is vital to ensure that an agreement is properly documented. At the time of contracting the parties can be full of optimism and a spirit of co-operation, but, like Eastgate and LRL, in time they may fall out.

One area which is often not fully considered by the parties is the ownership of IPR in the software. In relation to bespoke IT software development projects, particularly ones where the parties think they may be end up with a potentially lucrative and marketable product, it is important to document which party will own the copyright for each element of the software. Under the Copyright, Design and Patents Act 1988, in the absence of any contractual arrangements to the contrary, the copyright remains with the supplier for commissioned works. If the supplier is developing entirely bespoke software for a customer, the customer will wish to ensure that the IPR vests in it. However, there are other considerations.  It may be that the bespoke software is based on the supplier’s core product, in which case it would be usual for the IPR provisions to expressly state that the supplier owns the IPR in the core element of the system but that the customer is entitled to the IPR in any bespoke element designed specifically for that customer.

The parties also need to consider how the end product will be used. If the customer owns the IPR in the software and intends to either sell the system or make it available for third parties to use, as Eastgate did in this case, the supplier will wish to ensure that the contract sets out that it is entitled to a share of the revenues generated.  This is often in both parties’ interests as they can both be involved in marketing the product. If making the software available to third parties is a likely outcome, the parties need to ensure that the contract clearly sets out the terms on which the parties are to benefit. The contractual provisions may address points such as the percentage share that the supplier is to receive and what that share is in reference to.  The customer may wish to limit the length of time that the supplier is entitled to receive revenue. Finally, if the parties agree to jointly market a product, they may wish to identify categories of third parties to whom they are prohibited from marketing the product such as direct competitors of the customer.

The witness statements by representatives for LRL were inconsistent and had not thoroughly addressed the issues in the case. In addition, some of the witnesses were not able to answer questions in relation to parts of their witness statements. Part 32.4.5 of the CPR states that a witness statement should be in the witness’ own words and should be restricted to matters to which the witness can readily speak if cross-examined on it. It is the role of legal advisers to ensure that witness statements do reflect the witness’s own words and also that the witness is knowledgeable about the contents of his statement and able to discuss the issues in his statement in cross-examination.