The recent Court of Appeal judgment in Soteria Insurance Limited v IBM brings into sharp focus the need for practitioners to consider carefully the scope of exclusion clauses when drafting supply contracts to mitigate the risk of exposure to significant claims in damages. In this article, we consider the judgment of the Court of Appeal and its implications for best practice when drafting exclusion clauses.
In brief, the claimant, Soteria Insurance Limited (formerly CIS General Insurance Limited, "CISGIL"), entered into a Master Services Agreement ("MSA") with the defendant ("IBM") for the supply and management of a new IT system. IBM would first supply and implement the new system and would then manage it over the next 10 years. £50.2 million was payable by CISGIL for the implementation stage and £125.6 million for IBM's subsequent management services.
In 2016, significant delays caused by IBM meant that various completion dates were missed and, as a result, implementation of the system became unachievable by the longstop date in October 2017.
In March 2017, IBM issued an invoice in respect of software licences procured during the implementation stage, which CISGIL disputed on the basis of the delays. IBM sought to exercise a contractual right of termination for CISGIL's failure to pay the invoice, which CISGIL treated as a repudiatory breach and brought a claim for damages of £128m in respect of its wasted costs. That sum included: (1) costs incurred with third party suppliers and IBM prior to termination of the MSA; (2) post-termination costs; (3) interest paid by CISGIL on a subordinated loan; and (4) sums spent on legal fees, printing services, management costs, loan transaction fees and secondee costs.
Clause 23.3 of the MSA sought to exclude losses "which are indirect or consequential Losses, or for loss of profit, revenue, savings (including anticipated savings), data …, goodwill, reputation (in all cases whether direct or indirect) even if such Losses were foreseeable and notwithstanding that a party had been advised of the possibility that such Losses were in the contemplation of the other party or any third party."
The First Instance Decision
At first instance, O'Farrell J accepted that IBM had wrongfully repudiated the MSA but found that CISGIL's primary claim for wasted expenditure was excluded by operation of clause 23.3 (the Construction Issue). In consequence, the expenditure incurred by CISGIL in expectation that IBM would perform its contractual obligations under the MSA to implement and manage a new IT system was not recoverable. O'Farrell J therefore awarded CISGIL damages of c. £12 million in respect of IBM's repudiatory breach of contract. CISGIL appealed, primarily in relation to the Construction Issue.
The Court of Appeal Decision
The Court of Appeal overturned the first instance decision on the Construction Issue, thereby ordering IBM to pay damages of over £80 million to CISGIL. Coulson LJ (with whom Philips LJ and Zacaroli J agreed) provided five underlying reasons in support of the conclusion that wasted expenditure was not excluded by Clause 23.3:
- Natural and ordinary meaning of the clause
Coulson LJ concluded, having considered the wider contractual context, that applying established principles of statutory construction, the natural and ordinary meaning of the words in Clause 23.3 led "inexorably" to the conclusion that wasted expenditure should not be taken to have been excluded from recovery. The fact that other types of losses, including loss of data, goodwill and reputation, were specified alongside the typical consequential losses described above was telling of the intentions of the parties to exclude some, but not all, claims for losses.
- The need for clear and express language in exclusion clauses
Coulson LJ reiterated the established general rules applicable to the construction of exclusion clauses (and other clauses which might reduce the remedies ordinarily available to the victim of a breach of contract). Notably, per Diplock LJ in Gilbert-Ash (Northern) Limited v Modern Engineering (Bristol) Limited1, the starting point is the presumption that neither party intends to abandon any remedies for its breach arising by operation of law. Clear and express words must be used in order to rebut the presumption, and the more valuable the right that parties wish to exclude, the clearer the language needed. In this case, Clause 23.3 did not expressly specify claims for wasted expenditure as an excluded category of damages, and so the claim was not excluded.
- Different types of losses
The Court of Appeal went on to note that claims for loss of profit, revenue and savings (which it considered were consequential losses) are distinct from claims for wasted expenditure (which are reliance losses). The losses listed in Clause 23.2 were all consequential losses, which are forward looking and involve some element of speculation and conjecture, and are therefore often excluded from contracts given the difficulties in their accurate quantification. Reliance losses are more straightforward to calculate through receipts and invoices for costs incurred in anticipation of a contract being performed. Although both types of claims may be excluded, the Court of Appeal concluded that this clearly was not the case in the MSA, with Coulson LJ noting that this interpretation of Clause 23.3 made commercial sense as "the claims that would have compensated CISGIL for being better off as a result of the new IT system were excluded; the claims to compensate them for being worse off as a result of the non-provision of the IT system were not."
- Underlying loss of bargain
IBM submitted that CISGIL bargained solely for the savings, revenues and profits that it would have achieved had the implementation of the new IT solution been successful, and therefore clause 23.3 should be read as excluding all possible claims for damages resulting from the loss of this underlying bargain. However, by reference to Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Ltd2, the Court of Appeal concluded that the lost bargain was primarily the new IT system itself. Clause 23.3 should be treated as excluding some losses flowing from the loss of the underlying bargain (the loss of profits, revenue and savings) but not all (i.e. re-procurement costs and wasted expenditure). Otherwise put, the contract excluded the "aggrieved party's positive interests" but not "his negative interest, namely "expenses incurred and losses suffered in reliance on the contract."
Finally, Coulson LJ disagreed with O'Farrell's characterisation of "wasted expenditure" as a method of calculating "lost profits, revenues or savings". In his view, that was an "unjustified leap of reasoning". Just because, if the contract had been successfully performed, CISGIL's expenditure would have been recouped from its profits, did not mean that an ascertainable claim for such wasted expenditure was the same as a claim for lost profits. Indeed, lost profits (or revenue or savings) and a claim for wasted expenditure were two separate methods of calculating damages for the loss of a bargain.
The implications of the Court of Appeal's findings are far-reaching for lawyers drafting IT contracts, as well as lawyers drafting general commercial contracts that contain any type of exclusion clause. It is imperative that parties carefully consider at the outset what heads of loss are likely to occur in relation to the contract and, once contemplated, the contracting parties should ensure that these are expressly mentioned in the contract to give due regard to the nature of the underlying bargain. Where it is likely or inevitable that a particular type of loss will arise in the event of breach, it is safer to take a "belt and braces" approach and specify that particular head of loss. The risks of not doing so are particularly pronounced in the context of the implementation of high-value systems over the course of a number of years. Contracting parties should properly document all pre-contractual discussions surrounding the scope of recoverable losses and once they have done so, they should:
- use clear and express language in their drafting – if the parties seek to exclude claims for a specific type of loss such as for wasted expenditure, they should make express provision in the body of the contract;
- consider the natural and ordinary meaning of their final exclusion clause wording; and
- consider how their exclusion clause interacts with related clauses in their contracts, including the application of any further contractual cap(s).
Meanwhile, the Court of Appeal's confirmation that it was possible for CISGIL to recover wasted expenditure suggests a further narrowing of the distinction between contractual and tortious remedies. Historically, a party which wanted to "unwind" a contract, as CISGIL effectively did here, had to rely on bringing a claim under tort. However, this case illustrates that, subject to the terms of the contract, in a breach of contract claim the courts may effectively unwind a contract and put a party back into a position as if it had never been made.
Finally, the helpful clarification by the Court of Appeal regarding the interpretation of exclusions for "loss of profits" offers important guidance. Prior to this case, many recent decisions focussed on the distinction between "direct" and "indirect" loss of profit. This case makes clear that, irrespective of whether of "direct" or "indirect" loss of profits have been excluded, parties may still be liable for more than originally anticipated unless clear and unambiguous drafting has been used.