An important clarification
27th June, 2022
The Court of Appeal has provided an important clarification on what is recoverable loss and how exclusion/limitation clauses should be interpreted.
In the case Soteria (formerly CIS General Insurance) v IBM, CIS purchased a replacement IT system from IBM in order to better sell its various insurance products and services. It was a large project and involved an Agile (prototyping) methodology. However, beset by problems and delays, when a multi-million invoice was not paid by CIS, IBM terminated the contract. In reply CIS disputed IBM’s entitlement to do so, treated IBM’s actions as a repudiatory breach entitling CIS to treat the contract as terminated, and sought recovery of over £100m of wasted spend on the project.
Under English common law (case law) damages are compensatory in nature, which in the case of a breach of contract are designed to put the innocent party in the position they would have been in if the contract had been performed, but not a better position.
Similarly, a party in Soteria’s position must elect on termination of the contract between recovering either: The financial benefit it expected to achieve had the contract been properly performed e.g. expected profits and/or savings (‘Expectation’ losses); or its ‘Wasted Spend’ e.g. monies paid for services, licences, and with 3rd Parties, plus wasted management time (‘Reliance’ losses).
Whichever option is taken the innocent party must be able to prove the loss they claim. As such, whilst Expectation losses are often larger and more attractive, they are usually hypothetical and more difficult to prove; meaning Wasted Spend/Reliance losses, being ascertainable, are typically the losses that are claimed.
Whichever basis of loss is chosen it is in turn subject to the exclusion and limitation clauses in the contract. Typically therefore you will see the exclusion of Expectation losses, often described as: consequential loss, loss of profit, anticipated savings, revenues; and the exclusion of certain types and/or the capping of Wasted Spend/Reliance losses. However, when dealing with contract termination, identifying into which category each head of loss falls, and the dividing line between the two types of loss, is a complex and fertile ground for argument between lawyers.
O’Farrell J dealt with the Soteria case and a similar earlier case she had dealt with was relevant. Devon & Exeter NHS Trust v Atos 2017 was a claim by the Trust following a failed project to implement a new patient records system. The project was terminated by the Trust for alleged fundamental breach and its resulting claim to recover Wasted Spend was subject to a contractual exclusion of any ‘...loss of profit, business, revenue, and savings.‘ Other, largely Reliance/Wasted Spend, losses were subject to a time-based cap based on price paid.
Atos argued that (apart from certain costs spent on mitigation) the Trust’s Wasted Spend claim, being by a not-for-profit organisation, meant the loss of bargain for the Trust could be characterised as Expectation losses e.g. loss of savings. As such, the Trust’s claim fell within the above exclusion clause. However, O’Farrell J rejected Atos’ argument describing the non-pecuniary benefit as being (subject to a rebuttable presumption) at least equal to the amount the Trust was willing to pay for the benefit of the IT system. The Trust was therefore entitled to recover it’s wasted spend from Atos.
Although the result in favour of the Trust was the right one, many lawyers were uncomfortable with the above analysis, particularly the distinction made between pecuniary and non- pecuniary benefits for public/private entities.
Coming then to the Soteria case, O’Farrell J found IBM had breached the contract and then dealt with the application of a similar contract exclusion of ‘…loss of profits, revenue, savings (including anticipated savings),data and goodwill…’. However, this time O’Farrell J agreed with IBM’s submission, that although Soteria’s claim was said to be wasted spend it’s loss of bargain was to acquire profits and savings. As a result O’Farrell J decided the bulk of its loss was caught by the above exclusion.
Following an appeal by Soteria, the Court of Appeal disagreed with O’Farrell J’s decision for the following reasons:
- The natural and ordinary meaning of the words in the exclusion clause (being the objective reasonable man in the circumstances test) did not include wasted spend
- The more valuable the right being given up by the innocent party, so it must be ‘clear and obvious’ in any exclusion clause that this right was being excluded. In Soteria’s case there was nothing in the clause to suggest Soteria was giving up the spend it had incurred
- There were good commercial reasons for distinguishing between Expectation losses, which are hypothetical and Reliance losses (Wasted Spend), which were identifiable
- Loss of bargain could include the loss of a functioning IT system not simply pecuniary benefits
- Finally, it would be wrong to construe exclusion clauses based solely on the identity of the other party and whether the benefit arising was pecuniary or not. Often the benefits are a mix and could, for example, include the benefits of a more efficient and content workforce.
To conclude, this affirmation by the Court of Appeal of the distinction between the recovery of hypothetical/Expectation based loss or ascertainable/Reliance based loss is much welcome, as is the resulting guidance on construing exclusion and limitation clauses. In addition, this case is another timely reminder of pitfalls for a party who wrongfully terminates a contract (Soteria’s recovery increased from £13m to £80m + interest and costs).
Calculating damages and the effect of limitation and exclusion clauses is a tricky business, typically requiring specialist input.
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Please note that this briefing is designed to be informative, not advisory and represents our understanding of English law and practice as at the date indicated. We would always recommend that you should seek specific guidance on any particular legal issue.
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