Pinsent Masons advises EmpatKali founders in deal that signals Asia expansion for Afterpay
Out-Law Guide | 09 Sep 2011 | 3:17 pm | 10 min. read
In 2006 IBM (UK) Limited ("IBM") entered into a contractual arrangement to provide Southwark Borough Council ("Southwark") with a master data management system ("MDM") and associated consultancy services. The system's purpose was to harmonise and improve the management of data held on the Council's computer databases which held information relating to a variety of administrative departments, from housing maintenance schedules to council tax payments. It was intended that the software would provide a centralised database for all electronic information relating to the residents and residences of Southwark Borough. IBM had developed a new tool called 'Websphere' that was designed for this general purpose. There were extensive discussions between the parties about IBM's specialist MDM system and its ability to de-duplicate customer records, which would improve the efficiency of Southwark's day-to-day functions.
Southwark and IBM entered into an overarching "Framework Agreement" which was supported by three additional contracts that engaged additional third party contractors to provide additional software and technical support. A critical piece of additional software to be provided was 'Arcindex', which would work in tandem with IBM's Websphere application to assist in matching, de-duplicating and storing name and address relationships on Southwark's system. Arcindex was produced by Orchard, a third party contractor, entirely distinct from the IBM Group. The contract entered into by Southwark with IBM for the provision of the 'Arcindex' software took the form of an Order (the "Arcindex Order").
Both Arcindex and Websphere were delivered by IBM to Southwark by the end of April 2007, with Southwark's project manager declaring that the installation had been "100% successful". As part of earlier project planning, Southwark had undertaken to provide a "mapping specification" to IBM which would enable IBM to tailor the software in order that it would tag and locate duplicate documents in an efficient manner. Southwark did not provide this specification. As a result, Websphere and Arcindex were unable to provide the data in the format required by Southwark. In June 2007, Southwark appointed a new project manager, who raised concerns about: the user interface when searching for duplicate entries; the system's apparently limited search capacity; and, that there was no effective security function. On 19 July 2007, the MDM project was suspended by Southwark with limited consultation between the parties. The project manager stated that Arcindex did not "deliver required functionality". Notably, no blame was apportioned to IBM at this stage regarding the failure of the project. The project was shut down in its entirety on 3 August 2007.
Southwark commenced proceedings against IBM in August 2009 claiming, inter alia, that IBM had misrepresented the suitability of the Arcindex software. Southwark stated that the software was unfit for purpose and of unsatisfactory quality. In particular, Southwark claimed that Arcindex was "seriously deficient" in identifying and rectifying duplicate entries on the Council's database.
Southwark initially sought damages totalling £717,061, representing sums paid to IBM and Orchard, plus monies deemed to have been expended directly as a result of IBM's defaults. Amended Particulars of Claim submitted at a later stage in proceedings saw the claim for damages escalate to £2.5 million, taking into account further losses which Southwark attributed to the failure of the software.
In its original pleading, Southwark relied upon certain clauses of the Framework Agreement and upon a collateral warranty which provided that the Websphere and Arcindex programmes would interact in a manner so as to create a functional system fit for its intended purpose. Southwark also complained of several counts of misrepresentation and negligence. On 14 February 2011, Southwark abandoned its reliance on the Main Agreement, and recast its claim, pleading reliance on: (1) the software being unfit for purpose and of unsatisfactory quality in breach of Section 14 of the Sale of Goods Act 1979; and, (2) an express term of Clause 6.1 of Appendix A of the Arcindex Order.
BREACH OF the arcindex ORDER
The Framework Agreement stipulated the required quality standards that the software was to achieve. In turn, the Arcindex Order provided for the specifics of the software provision and determined the obligations of each party.
Key clauses of the Arcindex Order included:
Clause 1.3 stipulated that Orchard was to "have an ongoing responsibility to provide Arcindex software support."
Clause 6.1; Appendix A warranted that "the Software will be virus free, and will perform in accordance with the specification… Orchard does not guarantee that the Software is free of minor errors not materially affecting such performance."
Clause 6.2; Appendix A stated that "the Customer acknowledges that the Software has not been prepared to meet its individual requirements. Orchard shall not be liable for any failure of the Software to provide any facility not specified in the specification." Clause 6.3 of Appendix A also stated that "...Orchard has made no commitment to develop, modify or enhance the Software to meet the individual requirements of the Customer."
Clause 7.2 stated that "any warranties and indemnities relating to the Program … are the responsibility of the vendor ... There are no additional IBM warranties, and any implied condition or warranty of merchantability or fitness for purpose are excluded [emphasis added]." In this case, the vendor is the third party provider, Orchard. Southwark had independently selected Orchard as the third party provider of the software, and as such IBM were unsurprisingly unwilling to offer further input in the form of additional warranties.
Sale Of Goods Act 1979 ("SGA")
The SGA applies to contracts for the sale of goods, in which the seller transfers or agrees to transfer the property in goods to the buyer for a price.
On Southwark's case, IBM was in breach of its contractual obligation to deliver software of "satisfactory quality", insofar that the software was allegedly unable to produce the required level of search matches, and also there were restrictions in accessing individual user's workspaces.
Southwark stated that "satisfactory quality" should be interpreted as general suitability for purpose, and by reference to Section 14(2) of the SGA would include, amongst other things: fitness for all the purposes for which goods of the kind in question are commonly supplied and freedom from minor defects.
IBM defended itself by stating that it merely acted as a "conduit" in the provision of Arcindex to Southwark by Orchard, the third party contractor. At no stage did IBM recommend Orchard or Arcindex as a viable solution for Southwark, and nor did they mislead Southwark regarding the fitness for purpose or suitability of the products. According to IBM, Southwark employed high level technical staff to perform a thorough assessment of the product to ensure it met Southwark's requirements, and these experts had viewed demonstrations of what Arcindex could offer.
Southwark had also taken it upon itself to manage the whole MDM project, independently from IBM.
Unfair Contract Terms Act 1977 ("UCTA")
UCTA applies to unfair terms that may exist in commercial contracts. Section 6 UCTA states that an implied term stipulating a fitness for purpose requirement under Section 14 of SGA can only be excluded "in so far as the term satisfies the requirement of reasonableness."
Southwark stated that the exclusion of liability for fitness for purpose was unlawful and should be unenforceable under the provisions of UCTA.
Akenhead J. found that the Framework Agreement entered into by IBM and Southwark effectively excluded IBM's liability to the extent that warranties and indemnities in relation to the Arcindex software had become Orchard's responsibility, and that Southwark should have ensured that the Arcindex Order was inclusive of any warranties that were deemed to be necessary to give it sufficient contractual protection in the event of a dispute with Orchard.
The Arcindex Order
Initially, the Court examined the Arcindex Order to identify any express wording that would suggest that Orchard had agreed to terms that stipulated any quality standards or fitness for purpose:
The Court held that there was no requirement in the Arcindex Order that stated that the software "would be suitable for Southwark's specific or notified purposes." The Court stated that the "satisfactory" nature of the software would be determined by Clause 6 of the Order, which required the software to be virus free and contain the "extensive data searching facilities with access to comprehensive SQL-based searching and Appendix D". According to the Court, Orchard's software met those requirements and was deemed to be "satisfactory" to this extent.
"Fitness For Purpose"
The Court held there was no express warranty in the Arcindex Order that Arcindex would be suitable for Southwark's purposes. The Court would not find any obligation at common law for ensuring suitability, for fear of offending the express terms agreed by the parties.
All implied warranties of fitness for purpose had been excluded by the express provisions of Clause 7.2 of the Order.
Application of the SGA
The Court determined that in order for the statutory implied obligations under the SGA to be enforced against IBM, there must first exist under Section 2 (1) SGA, a "transfer" of "property in goods". It was held that there was no "transfer" of goods under the SGA. The Arcindex Order made between Southwark and Orchard makes reference to IBM "supplying" the Arcindex software. As such IBM was the facilitator of a licence being created between Southwark and Orchard and there was no transfer of property. Clause 8.1 of the Arcindex Order stated that "title, copyright and all other proprietory rights in the Software" remained vested in Orchard." The Court stated that this proved that ownership rights remained with Orchard, further supporting the fact that IBM had completed no qualifying 'transfer' under the SGA.
Software as "goods"
As the transaction did not satisfy the requirements of a "transfer", the question of whether software fell within the definition of goods was discussed obiter. The Court noted that a blank CD of minimal value would qualify as a personal chattel, and consequently "goods" under the SGA. The inclusion of software, music or other component upon that CD merely introduces a further attribute to that "good", and as such should not fall outside the definition. Consequently, both the CD and its content would be expected to be of satisfactory quality.
Accordingly, the Court held that, in principle, software could be goods within the meaning of the SGA, but noted that there is no binding authority in this regard.
Application of UCTA
The Court found that: (1) the two parties were of equal bargaining power; (2) Southwark had knowledge that IBM had excluded the implied terms and (3) Southwark had the opportunity to contract separately with Orchard. As such there was no element of unfairness or unreasonableness in IBM's exclusion of liability and UCTA would not intervene to strike the exclusion clause from the contract.
The Court dismissed Southwark's claim for damages for breach of the SGA and found judgment in favour of IBM.
The SGA defines "goods" as "all personal chattels other than things in action and money". Southwark confirmed that if software is delivered via a physical medium (a CD, for example), then both the CD and its contents would be expected to be of satisfactory quality. If they were not, the customer is entitled to request a replacement, repair or refund. The intangible nature of "software", however, meant it was excluded from the remit of the SGA. The SGA is, of course, a piece of pre-digital technology legislation, and its definitions are inevitably outdated.
Southwark v IBM draws attention to the unclear categorisation of software in relation to the SGA's definition of "goods". This uncertainty surrounding the categorisation of software has not been suitably clarified by any recent case law, with the courts preferring to deliver commentary rather than finally decide the matter. In Southwark v IBM, the Court stated that there is no reason in principle why software cannot be categorised as "goods" for the purposes of the SGA.
However, on Southwark's facts, there was no qualifying "transfer" of "goods" which meant that the Court's statements on this issue were obiter and did not form part of the substantive judgment. As such, a definitive statement on this issue is still awaited. Although the law in this area remains unhelpfully unclear, judicial recognition that software may constitute "goods" provides some comfort and certainty for consumers (and, of course, suppliers). The European Commission is consulting on future developments in consumer law and it is hoped that the rights of purchasers of tangible and intangible goods may be clarified.
Southwark v IBM also highlights the benefits of software manufacturers ensuring that they only provide licences for their products, rather than engaging in a "sale". In Southwark, Orchard had expressly reserved its ownership rights through retention of title and protection of intellectual property clauses, and, accordingly, there was no qualifying transfer under the SGA. As such, Orchard had successfully excluded the obligation to provide a product that was fit for Southwark's specific purposes. A term of this nature is beneficial for a small third party contractor (supplier) such as Orchard, however, it should be avoided by a customer (or licensor) entering into a high value contract. The reason being that if a customer purchases a deficient product it would then have no legal remedy and may incur significant financial losses.
A final point of interest in the Southwark judgment was the consideration of when express warranties given by third party contractors for specific goods can supersede any general warranties provided by a primary contractor. These general warranties (which the purchaser may have relied heavily upon when entering into the contract) may in such circumstances be unenforceable. Taking this into account, it is critical to ensure clarity in commercial contracts as to the subject / object of warranties, and the parties must ensure there is precision regarding the requirements of a software system that is being provided ‘out of the box’, rather than a bespoke design. Furthermore, express provision should be made for the rights and remedies that the parties will be entitled to in the event that the product does not meet these standards, ensuring that the purchaser is able to pursue the party of its choosing in any legal proceedings. Finally, the party taking ownership of the product must ensure that if it agrees to evaluate the product for its own purposes, it must do so thoroughly, in order to ensure it is perfectly suited to its requirements, in order to not fall outside any general warranties (i.e. a piece of software may not deliver some key functionality, and, therefore, not meet the purchaser's specific requirements, but it may still be of "satisfactory quality").
Pinsent Masons advises EmpatKali founders in deal that signals Asia expansion for Afterpay