Risks in terminating IT contracts highlighted by exclusion clause ruling

Stuart Davey and Meghan Higgins of Pinsent Masons, who specialise in the resolution of disputes over IT contracts, were commenting after the Court of Appeal ruled that an insurance company is entitled to more than £80 million in damages from an IT supplier that was ruled responsible for a repudiatory breach of the contract between them.

A party to a contract may be said to have 'repudiated' if they act in a way that makes clear they do not intend to be bound by their obligations under the contract. If the innocent party accepts that repudiation, the contract will come to an end. The innocent party may then bring a claim for damages, including damages to provide it with the full benefit of the contract had it been performed rather than repudiated.

The case before the Court of Appeal concerned a dispute over the amount of damages that CIS General Insurance Limited (CIS), now known as Soteria Insurance Limited, is entitled to from IBM United Kingdom Limited (IBM). IBM had previously been ruled responsible for a repudiatory breach of the contract in relation to the supply and management of a new IT system for CIS. IBM had terminated the contract with CIS following non-payment of an invoice but, following a trial, the High Court considered that IBM had not been entitled to exercise termination rights and had repudiated the contract.

Before the High Court, CIS's primary claim against IBM was for damages of £128 million in respect of wasted expenditure. The High Court ruled, however, that the claim was excluded as a result of an exclusion clause in the parties’ contract.

CIS raised an appeal against that judgment. The Court of Appeal has now ruled that the High Court had wrongly interpreted the exclusion clause in the contract and held that CIS is entitled to an award of more than £80m in damages from IBM in relation to its wasted expenditure.

Higgins said: “The contract between CIS and IBM had a fairly standard exclusion clause identifying specific types of losses that would be excluded from liability, including ‘loss of profit, revenue, savings (including anticipated savings)…’. The High Court reasoned that although CIS’ claim was framed as one for wasted expenditure, it was in effect a claim for the loss of the bargain struck under the contract, seeking the savings, revenues and profit that CIS would have achieved if the project had been successful.”

“The High Court held that the purpose of the contract and benefit under it was for CIS to secure costs savings and increased revenues through the use of the IT system and that the wasted expenditure was an alternative way of asserting a loss of bargain claim. CIS’ claim for wasted expenditure accordingly failed as the High Court deemed it excluded under the contract. The decision attracted widespread criticism in the legal press. The exclusion clause was fairly standard for a major IT contract and there was significant concern among technology lawyers and contractual lawyers more generally about the impact of this interpretation of an exclusion clause on future claims. The decision also seemed inconsistent with previous case law,” she said.

“The Court of Appeal reviewed at length the authorities establishing that where a claimant seeks damages for the defendant’s repudiatory breach, the claimant can elect to claim either for its loss of profits or for its wasted expenditure. It referred to case law that says that there was a rebuttable presumption that the claimant would have recouped the expenditure incurred in reliance on the defendant’s performance of the contract and ultimately concluded that the High Court’s construction of the exclusion clause was incorrect,” Higgins said.

Five reasons why the High Court’s construction of the clause was wrong were cited by the Court of Appeal, reflecting on, among other things, the natural and ordinary meaning of the exclusion clause – which it held did not seek to exclude losses for wasted expenditure. It also said the High Court was wrong to conclude that wasted expenditure was impliedly included within the umbrella of lost profits, revenue or savings, finding instead that there was a recognisable distinction to be drawn between loss of profits, revenue or savings, and wasted expenditure.

Higgins said: “The Court of Appeal considered that losses of profits, revenue and savings are all of a similar kind considered to be the types of consequential loss which would involve consideration of hypothetical scenarios as to benefits and savings obtained had the contract been performed. These claims are difficult to estimate in advance and because they are so speculative are routinely excluded by similar clauses. By contrast, a claim for wasted expenditure is readily quantifiable and is not usually regarded as a claim for consequential loss. The court considered that there would be a reasonable commercial justification to exclude claims for loss of profits, revenue and savings but not for wasted expenditure.”

The Court of Appeal also found that, under established principles for the construction of exclusion clauses, the more valuable the right, the clearer the language of the exclusion clause would need to be to avoid the non-performing party avoiding liability – in this case, it considered that the exclusion clause was not to be interpreted as suggesting that costs that CIS incurred in the expectation the project would be completed would be irrecoverable if IBM repudiated the contract.

The Court of Appeal further concluded that CIS had suffered losses in addition to the loss of profit, revenue or savings. CIS had wanted to obtain the IT system itself, so it said it was “fundamentally incorrect” to say that the loss of profits, revenue and savings was the sole loss incurred by CIS as a result of the repudiation. Other financial losses could result from the loss of the bargain, according to the court, which cited potential costs associated with a re-procurement exercise as an example.

Stuart Davey said: “The Court of Appeal’s reversal of the High Court’s finding on the interpretation of the exclusion clause and its careful review of the principles governing these types of clauses will be welcomed by contracting parties in IT projects where similar clauses apply. It should also serve as a warning of the need for care to be taken when seeking to exercise termination rights under contracts for failing projects as this case highlights how unpredictable the outcome may be. A legal review of programme delivery is recommended to identify features of transformational IT projects that can lead to disputes and ensure businesses are well-placed to address them.”