Out-Law Guide | 02 Nov 2007 | 8:31 am | 7 min. read
Sam Business Systems Limited v Hedley and Company (sued as a firm)
The Claimant software supplier, SAM, and the Defendant, Hedley, entered into a Licence Agreement and a Maintenance Agreement in respect of computer software supplied to Hedley for use in its stockbroking business. Hedley was a small firm and had been using a dated, DOS-based system which Hedley believed was not millennium compliant. Hedley had contracted for SAM’s InterSet system, which was to be used to automate the settling of trades, to interface to CREST, to maintain customer portfolio records, and so on. InterSet was a standard system which was configured to the customer’s requirements.
The Licence Agreement and the Maintenance Agreement were signed on 18 October 1999 and both agreements incorporated SAM’s standard terms and conditions. The Licence Agreement contained what the Judge described as a “‘belt and braces’ collection of overlapping exclusions and limitations of liability”. Clause 3.2 contained a broad exclusion of warranties, including statutory implied terms:
“[T]here are no warranties, either expressed or implied, by this agreement. These include, but are not limited to, implied warranties of merchantability or fitness for a particular purpose, and all such warranties are expressly disclaimed to the extent permissible by law.”
Clause 3.3 sought to exclude responsibility on the part of SAM for all significant heads of damage and to cap liability for any remaining damage to the amount of the licence fee:
“… SAM will not be responsible for any direct, incidental or consequential damages such as, but not limited to, loss of profits resulting from the use of the software, even if SAM have been advised of the possibility of such damage … [A]ny liability to which SAM might otherwise become subject shall, in aggregate, be limited to the licence fee paid.”
The Licence Agreement also contained an entire agreement clause which stated that the agreement constituted the entire agreement between the parties and that it superseded all prior representations.
Notwithstanding these very broad exclusions and limitations, clauses 2.10 and 2.11 contained a “money back guarantee”. If, after a defined period, the software still did not meet its acceptance criteria, Hedley was entitled to reject it and get its money back:
“2.10 30 days from delivery of the application software by SAM, acceptance tests will be completed by the client in order to test the application software … Client will advise SAM of any instances where the application software fails to achieve the stated acceptance criteria. Such advice shall be in writing … Any individual software component reissued by SAM … may be subjected to retesting by client for a further 30 days … If, having followed these procedures, and within 90 days from the original date of delivery, there remain acceptance criteria correctly notified by client according to the procedures outlined above but not achieved by the application software, client shall be entitled to initiate procedures for rejecting the application software … In the absence of a valid written advice from client … the application software will be deemed accepted.
2.11 In the event of the application software not being accepted according to the obligations and procedures outlined in sections 2.9 and 2.10, client shall have the right at its entire discretion to rescind this agreement and to be repaid all sums which have previously been paid to SAM in respect of the licence under this agreement. This shall be the sole and exclusive remedy available to the client in the event of the application software not being accepted.”
The parties managed to achieve go-live before the millennium. However, after installation, the software was beset with technical problems. These led to, among other things, increased costs of working due to the need to operate workarounds. Hedley also said that these problems caused it to get into difficulties with the regulator. About a year after go-live Hedley decided to stop using the software and to outsource the relevant back office functions to another company, Pershings. It went live with Pershings in about June 2001. Plainly, then, Hedley did not reject the software within the timescales required by clause 2.10.
SAM brought proceedings for £310,000 said to be due in respect of the licence fee, post-installation maintenance and other services. Hedley defended the claim on the basis that it was entitled to rescind the Agreements for misrepresentation and had done so, alternatively that SAM was in repudiatory breach of contract. Hedley sought to recover damages amounting to £790,000, a sum which included the cost of the system and loss of profit.
The Judge found that the software was defective and that SAM’s statements about InterSet being highly automated had proved untrue. Both parties accepted that, subject to the contractual limitations and exclusions, the Licence Agreement was subject to a number of implied terms, including a term that InterSet would be reasonably fit for its intended purpose, and a term that InterSet would be of satisfactory quality. These terms were along the same lines as those implied in St Albans City & District Council v ICL  4 All ER 481. These implied terms had been breached. The question, then, was whether the limitations and exclusions were effective in protecting SAM from liability for these failings.
The Judge held that although the software was defective and had never worked properly, Hedley’s failure to reject it in accordance with the timescales and procedures laid down by clauses 2.10 and 2.11 deprived it of any remedy. SAM was entitled to the balance of the licence fee (£7,467 excluding VAT), but its claim for additional charges (including a claim for the costs of putting right defects in the software) failed.
The exclusions and limitations on liability in clauses 3.2 and 3.3 of the Licence Agreement satisfied the test of reasonableness under sections 3 and 11 of the Unfair Contract Terms Act 1977. The Judge found that the parties were of equal bargaining power in terms of their relative size and resources. Although Hedley had a millennium compliance issue, this was of Hedley’s own making and therefore not a point that should be weighed when assessing bargaining power. Further, although there was some evidence that the limitation clauses were similar to those included in the standard terms of SAM’s competitors, limiting Hedley’s ability to contract on different terms, the fact that Hedley had not even tried to negotiate more favourable conditions with SAM limited the amount of weight which the Judge attached to this consideration. The Judge did say, however, that if SAM had not offered the “money back guarantee” in clauses 2.10 and 2.11, the exclusions of liability in clause 3.2 and the entire agreement clause (clause 3.6) would have been unreasonable (although the limitation of liability to the sum paid under the Licence Agreement (clause 3.3) would have been reasonable).
The Court of Appeal’s decision in Watford v Sanderson appeared to signal a hardening of judicial attitudes towards attempts by commercial parties to escape the consequences of exclusion and limitation clauses by relying on UCTA. The essence of the Court of Appeal’s reasoning was contained in the following passage from the Judgment of Chadwick LJ:
“Where experienced businessmen representing substantial companies of equal bargaining power negotiate an agreement they may be taken to have had regard to the matters known to them. They should, in my view, be taken to be the best judge of the commercial fairness of the agreement which they have made; including the fairness of each of the terms in that agreement. They should be taken to be the best judge on the question whether the terms of the agreement are reasonable. The Court should not assume either is likely to commit his company to an agreement which he thinks is unfair, or which he thinks includes unreasonable terms. Unless satisfied that one party has, in effect, taken unfair advantage of the other – or that a term is so unreasonable that it cannot properly have been understood or considered – the Court should not interfere.”
In SAM v Hedley the Judge did not question the authority of Watford v Sanderson, but his consideration of the reasonableness of the exclusion and limitation clauses reflected the traditional approach of weighing up the “reasonableness” factors set out in UCTA together with all the circumstances of the case.
The Judge’s approach, which involved identifying the business realities which underlay the contract, was epitomised in the following passage in his judgment:
“Before contract, SAM says, ‘We think our system is marvellous and will do everything you need, but if you are not satisfied you can ask for your money back’. The contract, signed by Hedley’s after they have had a few days to think about it but without any attempt to negotiate on their part, says, ‘So far as possible we exclude any liability for our system, but if you are not satisfied and go through the right machinery, you can have your money back’. Having regard to the enormous potential liabilities, that seems to me to be a reasonable arrangement in the circumstances existing between the two parties”.
What is most noteworthy about this case is that the judge stated that, but for the “money back guarantee” he “would have regarded the exclusion of liability and entire agreement clauses as quite unreasonable”, notwithstanding that the parties were commercial organisations of equal bargaining power. To the extent that commentators had speculated that Watford v Sanderson removed the scope for a Judge at first instance to strike down a clause in a commercial IT contract as unreasonable, the Judge’s reasoning in SAM v Hedley suggests that such speculation was wide of the mark.
If the Judge had felt the need to justify his observations as to the enforceability of the limitation and exclusion clauses, he could have done so by invoking one of the exceptions (ie. that one party has, in effect, taken unfair advantage of the other, or that a term is so unreasonable that it cannot properly have been understood or considered) referred to in Chadwick LJ's judgment in Watford v. Sanderson (quoted above). He could have reasoned, for example, that the fact that clause 3.3 purported to exclude liability for direct loss, as well as indirect loss, suggested that it had not been properly understood or considered. In fact, the Judge did not even refer to that passage from Watford v. Sanderson, instead basing his findings on reasonableness on a traditional weighing up of the all the relevant circumstances.