Commercial Law Updates - An Analysis Of Cases And Developments From September 2010

Liquidated damages do not necessarily have to be a genuine pre-estimate of loss

AB is an Italian company which builds luxury yachts. It negotiated the sale of a yacht with Mr Healey. The price was €38million, payable by instalments. The contract was entered into with Shoreacres Limited, a company owned by Mr Healey, who entered into a personal guarantee in respect of the company's obligations. The contract included a liquidated damages clause which provided that on termination by AB, Shoreacres would pay an amount equal to 20% of the contract price as compensation for estimated losses and AB was to return the balance of sums received together with Shoreacres' supplies if not yet installed in the yacht. Shoreacres failed to pay the first instalment so AB eventually terminated and claimed under the liquidated damages clause. It sought summary judgment of sums due under Mr Healey's personal guarantee.

Mr Healey argued that the 20% was a penalty clause aimed at deterring breach which exceeded the maximum possible loss. 20% of the contract price payable cannot have been foreseen by the parties as conceivably representing AB's loss when the contract was entered into, especially as it was payable on the accounts of several events, some of which may have occasion serious and others trifling damage. In order for the court to determine whether it was a penalty clause, there would have to be extensive disclosure, so the matter was not suitable for summary judgment.

Much of the evidence concerned the negotiations over the termination clause. Although evidence related to negotiations, it was permitted as demonstrating that the reasons that the parties had for opting out of common law remedies constituted adequate justification for the discrepancy between the contractual measure of damages and that provided by the common law.

The evidence was muddied because negotiations had taken place in relation to two vessels with different purchasers, but with the same lawyers and agents on each side. In relation to the other vessel, Holman Fenwick, acting for AB, were repeatedly asked to reduce the percentage for liquidated damages fee to 10%. Holman Fenwick repeatedly refused (copying their reply to Shoosmiths and Shoreacres's agents), saying that 20% was a genuine preestimate of loss and that if 20% was not acceptable, then an alternative, more conventional model could be used instead, whereby AB would complete and sell the yacht to someone else and then account to Shoreacres for any excess remaining. Given the three year build period, this would extend the recovery period for Shoreacres considerably.

The Judge, Mr Justice Blair, granted summary judgement in favour of AB. He reviewed the authorities and in particular relied on a dictum in Cine Bes Filmcilik VE Yapimcilik v United International Pictures that a particular clause "might be commercially justifiable provided that its dominant purpose was not to deter the other party from breach". He went on to say that a Court has to be careful not to set too stringent a standard and bear in mind what the parties have agreed should normally be upheld. The purpose of the clause was to strike a balance between the interests of the parties, should AB lawfully terminate upon Shoreacres's breach – and here it was relevant that AB was also under an obligation, namely to return the balance of sums received, together with Shoreacres's supplies if not yet installed.

The dichotomy between a genuine pre-estimate of damages and a penalty does not necessarily cover all possibilities. There are clauses which may operate on breach but which fall into neither category, and they may be commercially perfectly justifiable, provided that their dominant purpose is not to deter the other party from breach. Here, the evidence of the discussions about the clause was relevant, including the offer of an alternative, and the stated advantage that the contract clause gave an immediate refund to Shoreacres (assuming Shoreacres had paid more than 20%). The Judge took the view that the evidence clearly showed that the purpose of the clause was not deterrent and that it was commercially justified as providing a balance between the parties. On that basis, there was no need for the Court to form a view as to the maximum loss which the parties would have expected to flow. The clause in question was not even arguably a penalty and was enforceable in accordance with its terms.

Two further points. First, Mr Healey had also argued that, because the 20% payment was a penalty, the obligations under his personal guarantee should also fall away. AB disputed this on the wording of the guarantee which stated that the liability of the guarantor was not to be "impaired, diminished, discharged or released by reason or in consequence of the illegality, unenforceability etc ... of the contract". The Judge agreed with Mr Healey's argument. A guarantor's liability need not be co-extensive with that of the principal debtor, but if the original obligation failed as a matter of public policy on the grounds that it was a penalty, then the same public policy would apply to recovery of the sum under the guarantee.

Secondly, Healey had argued that, because AB had elected to terminate and recover liquidated damages, it was precluded from seeking to recover the first instalment (which had fallen due before the contract was terminated), if the 20% was found to be unenforceable as a penalty. The Judge rejected this and stated that, if the liquidated damages had been found to be a penalty, AB could nonetheless have recovered the first instalment. He did not consider that AB was relying exclusively on the liquidated damages clause or that in context its argument was contradictory. The position fell within the House of Lords decision in Hyundai Heavy Industries v Papadopoulos.

This case appears to widen the scope of liquidated damages that can be specified upon breach of a commercial contract. As long as the remedy can be shown to be commercially justifiable and is not intended to be a deterrent, it is likely to be enforceable rather than a penalty, even if there is a discrepancy between the amount payable and the amount of likely loss. To succeed, proposing an alternative to liquidated damages is a good idea, as is conferring some benefit on the party in breach as part of the liquidated damages structure. Nevertheless, it is still safest for the sum to be calculated as a genuine pre-estimate of loss for a particular breach – and make sure that there are workings to show how any figure was arrived at.

Notice period cuts compensation for commercial agent

In litigation over sums due under the Commercial Agency Regulations on termination of a commercial agency agreement, the experts of the parties agreed the compensation that should be payable under the principle set out by the House of Lords in Lonsdale, namely the sum which could reasonably have been obtained at the date of termination for the rights which the agent had been enjoying, assuming that the agency would have continued and that the purchaser would have been able properly to perform the agency contract. When agreeing the sum payable, the experts took annual income, factored in projected growth, deducted costs (i.e. producing a figure for profit), applied a multiplier on profits and then reduced the final figure by 25% to allow for (i) the lack of a written agreement and (ii) the risk of termination. Alternative figures were agreed, depending on whether the agreement was found by the Court as being exclusive or non-exclusive.

The Judge (HH Judge Behrens) found that the agency was exclusive (thereby putting in play the higher figure for compensation), but disagreed with the experts over the amount of discount. The 25% discount to allow for risk of termination was fine in respect of the lack of a written agreement (of relative unimportance) but did not take proper account of the fact that the agreement was terminable on one year's notice. The discount of 25% was far too small. The Judge doubted that anyone would pay more than one year's net income, so he reduced the compensation to that figure, which was about 40% of that agreed by the experts.

The case is interesting because it does bring notice period into the matter of valuation of an agency business, something not specifically considered in Lonsdale . It indicates is that, from the principal's point of view, a short notice period will reduce the principal's liability to pay compensation on termination considerably. Previously, the general thinking was that, notwithstanding Lonsdale, a principal was better opting for the indemnity basis for the payment on termination because it is capped at a year's remuneration for the agent. This case indicates that it may be better for the principal to elect for the compensation basis along with a short period of notice – and bear in mind that under the Commercial Agency Regulations only three months is required, and then only for the third year onwards.

In-house lawyers unable to claim legal professional privilege in competition investigations

The European Court of Justice (ECJ) has published its much awaited judgment on the privilege position of in-house lawyers who advise on competition investigations. The judgment has confirmed the existing limitation on the ability of European in-house counsel to claim legal professional privilege in competition investigations by the European Commission. This decision is likely to cause consternation and controversy amongst in-house lawyers across Europe as it was hoped that the ECJ might take the opportunity to change the law in this area. A CR Note on the subject – click here - considers the scope of the ruling, as well as reviewing, by way of background, the basic principles of privilege under English law.

Department of Work and Pensions ordered to release IT contract details

The First Tier tribunal has held that DWP must disclose under the FOIA most of the information specified in an FOI request relating to the contract between it and Atos Origin for IT services for the Government Gateway . DWP had argued that the section 43 exemption for trade secrets and prejudice to commercial interests allowed it to withhold the information. By the time of the hearing, it still refused to divulge details of liability caps, performance requirements (e.g. key performance indicators ("KPIs") and service levels), the benchmarking model, charges, Atos' financial model, change control notifications and location of the data centre. It claimed that disclosure would prejudice the commercial interests of DWP on the grounds that disclosure would prejudice DWP's ability to obtain best value for money in future contracts (the argument being that data known to competitors would be used to offer only the same or slightly better terms). It also claimed that the matters to be disclosed were trade secrets of Atos, a claim which was undermined by the fact that by the date of the hearing Atos only objected to disclosure of its financial model.

The Tribunal held that all the information was covered by s43 as being "likely to prejudice" the commercial interests of DWP. There was a causal relationship between the disputed information and future government procuring of IT services and a real risk to the competitive environment. However, the evidence did not support the allegation that disclosure "would prejudice" the commercial interests, a finding which was relevant in relation to the public interest test.

The s43 exemption is a qualified exemption in that there is a second test to withholding, namely that the public interest in maintaining the exemption must outweigh the public interest in disclosure. Here, the Tribunal made the point that the public interest in maintaining the exemption is likely to be stronger if disclosure would prejudice rather be likely to prejudice DWP's commercial interests. It applied principles observed from previous decisions, such as the design of the Act being to shift the balance to greater openness and the public interest in better government though transparency occasioned by disclosure. Here the public interest in knowing that there were adequate service levels etc was "a much weightier factor" than any reduction in competition and discouragement of incumbent suppliers and SMEs from bidding for new contracts. This was particularly so because the previous contract for the Government Gateway had failed and the there was a public interest in knowing that adequate service levels etc were in place. Thus the Tribunal ordered disclosure of all items on the basis that public interest in disclosure outweighed public interest in maintaining the exemption.

The Tribunal did, however, make an exception for Atos' financial model which was held to be a trade secret, where it was in the public interest for secrecy to be maintained. The same went for the precise location of the data centre in which information was held, where it was found to be in the public interest to reduce the possibility of an attack on the centre (even though Atos admitted that it would not be difficult for someone determined to locate it). The Tribunal held that it was sufficient for the country of the data centre to be identified.

The upshot is that anyone doing business with the public sector should plan on the basis that all but the most secret information may end up in the public domain.

Further possible changes to Late Payments Directive

In April 2009 the European Commission issued a press release in which it proposed to alter substantially the Late Payments Directive on the grounds of overwhelming evidence that late payment in commercial transactions was still a problem, with public authorities in Member States being particularly bad. The recast Directive proposed that public authorities should pay within 30 days or pay 5% compensation plus interest, there should be late payment interest and the minimum claim of €5 should be abolished.

According to a press release, the points agreed between Parliament and the Council were:-

• The standard deadline for public and private companies to pay should be 30 days. Only in exceptional circumstances can the payment period be longer and then 60 days should be the maximum for public authorities. It is not clear what the position is for private sector customers, nor whether the public sector can pay by instalments (one of the concerns being that payment by instalments could enable public authorities to circumvent the Directive).
• The statutory interest rate will be the reference rate plus 8%. Compensation for recovery costs will be a fixed sum of €40.
• The time for payment by public entities providing healthcare will be 60 days, instead of 30, because they are largely funded through reimbursements under social security systems.
• The verification period for ascertaining that goods or services comply with contract terms is 30 days. This period may only be extended if expressly agreed and provided that it is not grossly unfair to the creditor. In other words verification periods may not be used as a way to circumvent the regulations. The next step is that the Commission will publish a draft Directive.

E-Privacy Directive – BIS Consultation

BIS has issued a consultation on implementation of the revised E-Privacy Directive which requires a number of changes to English law. The consultation seeks views on some of those changes:

• Data security breach notification. The Government proposes to copy the revised wording of the Directive which requires providers of public communications services to notify the national regulator of any "personal data breach". The ICO will be authorised to provide guidance on the notification mechanism.
• Penalties. The existing enforcement regime under the Data Protection Act is being reviewed by the Government and ICO. The consultation seeks views on the additional sanctions in the revised Directive, together with comments as to how the provisions of the Directive could be better enforced.
• Cookies. A controversial subject mentioned in previous bulletins. The Government proposes to replicate the wording of the E-Privacy Directive. It is against the establishment of an opt-in system for cookies which it considers would lead to a permanent disruption of services. It intends that online providers will be permitted to take advantage of the provision in Recital 66 (of the Citizens Right Directive, which is being brought in at the same time) that states that users' consent to cookies may be expressed by way of browser settings. The ICO is to be left with the flexibility to adjust to changes in usage and technology. This approach is at odds with that adopted by the Article 29 Working Party which has demanded stricter opt-in standards for cookies. This subject is set to run and run.
• Information provision. This relates to the requirement on service providers have procedures in place to supply the police and security services with details of usage of electronic communication services – including what is presently required under the Regulation of Investigatory Powers Act 2001. The Government proposes that the ICO should have the ability to question communication providers about their procedures. Providers would be expected to bear the cost of implementing the procedures.

Unfairness of ancillary charges

It will be recalled that, in the Abbey National case, the House of Lords held that ancillary charges (essentially overdraft charges) formed part of the price bargain between the banks and consumers and as such were excluded from the test of fairness by Section 6(2) of the UTCCR. The UK Government has been calling for evidence on ancillary charges in light of the Consumer Rights Directive.

As expected, the OFT has responded by calling for greater clarity in the application of the Directive to ancillary charges. It considers that the key issue is transparency in that ancillary charges should be covered by plain language and should be noticed and understood by consumers when they enter into a contract. Ancillary charges are not necessarily bad, as long as their potential liability is understood at the outset. To that end, it considers that the s6 (2) type price exemption should focus on core pricing issues and cover only so much of the price as forms part of the essential bargain. Charges should not be part of the essential bargain if they are not likely to be foreseen by a consumer at the time of contract, or if they are sufficiently remote as to have been unlikely to be factored into the consumer's initial decision to enter into the contract.

OFT market study into advertising of prices

The OFT has published a set of proposals which it will use as a starting point in assessing whether a pricing promotion breaches the Consumer Protection from Unfair Trading Regulations. Proposals are made in respect of the following:

The proposals are to be discussed at meetings with industry stakeholders, consumer groups and other interested parties. Once finalised, they are intended to act or serve as a reference point which traders can use when considering their pricing promotions.

Incoterms 2010

The ICC has published new Incoterms which will come into effect on 1 January 2011. They will be known as Incoterms 2010.

The terms DAF, DES, DEQ and DDU have all been abolished and are replaced by DAT (delivery at terminal) and DAP (delivered at place).

There are now 11 terms, of which the first seven can apply to any mode of transport. The last four apply to sea and inland waterway transport (these include the best known FOB and CIF terms). In the Incoterms booklet (which is in LFP library and in Bahrain), each term is introduced by a guidance note and diagram showing where delivery occurs. This is then supplemented by the rules applicable to the term. Everything is set out in a user friendly and clear manner.

Remember that Incoterms do not describe the goods or deal with warranties, liabilities, price and payment, title, intellectual property, law and jurisdiction.

Equality Act comes into force

The Equality Act 2010 came into force on 1 October 2010.

Resale of licensed software prohibited

Mr Vernor purchased genuine copies of Autodesk software from licensed users for sale on eBay. Autodesk alleged that such sales amounted to software infringement.

The US district court held that the "first sale" doctrine applied, i.e. where a copyright holder chooses to sell a copy of his work, he exhausts the statutory right to control its distribution, so that the owner of a lawful copy of the copyrighted work is entitled to sell it (but not to exercise other prohibited acts such as copying the work). The decision was based on a case called Wise where the Court took the view that wherever there was no requirement for the recipient to return licensed materials(in this case, film prints), then the transaction amounted to a sale rather than a licence, not withstanding that other terms were imposed on the recipient of the materials.

The US Court of Appeals for the Ninth Circuit allowed the appeal and overruled the first instance decision. The Court of Appeals held that, because Autodesk reserved title under its licence agreement, its customers were licensees of their copy of the software, rather than owners. As the licensees did not purchase the software as owner, it followed that they could not evoke the first sale doctrine.

The Stig's Identity had ceased to be confidential information

In August 2010, the BBC sought an injunction against HarperCollins, Ben Collins (a racing driver) and his service company, Collins Autosport Limited. The court refused the application.

The BBC failed in its attempt because the identity of Mr Collins as the Stig had already entered the public domain and it would not be proper use of the Court's power to grant an injunction merely to punish a defendant for his previous unlawful action, where the injunction does not protect the claimant against further harm.

One point of interest for the purposes of this bulletin was the question of whether Mr Collins owed a contractual obligation of confidentiality to the BBC. All of the contracts were between the BBC and Collins Autosport, on whose behalf Mr Collins signed. Most of them contained an obligation against disclosure of the identity of the Stig. The Court rejected the BBC's contention that Mr Collins was a party to the contract. Although he signed the contracts, he did so on behalf of his service company which was the relevant contracting party. He did not, by his signature, become a further party to the contracts. The contract contained obligations such as "you will not reveal your identity", something the Judge attributed, no doubt correctly to the parties not thinking through the consequences of the contracting party being a service company, rather than the individual performer. Nonetheless, the Judge held that it was not an absurd suggestion that the company should not reveal its identity – if it did so, that would indirectly reveal the identity of Mr Collins. The words meant that either the service company would not reveal its identity or that the service company would not reveal its identity or the identity of Mr Collins. In either case, Mr Collins was not bound by a contractual duty.

However, the judge did hold that there was, nonetheless, a duty of confidence in accordance with equitable principles, since it had been made abundantly clear to Mr Collins how important the anonymity of the Stig was to Top Gear. This duty of confidence ceased to apply to the identity of the Stig when it came into the public domain in newspaper articles.

The finding that there was no contractual duty highlights the obvious point that if a person is to be contractually bound, that person must become a party to a contract in its own right. This principle applies not just to service companies, but in many other contractual situations, for instance, where group companies are involved. Bear in mind that the Contracts (Rights of Third Parties) Act only entitles third parties to enforce (i.e. take the benefit of) a contract, and cannot impose obligations on them.

ISPs to bear 25% of copyright notification costs

In March 2010 the BIS consulted on proposals for the way in which costs were to be shared in relation to the "initial obligations" required of ISPs under the Digital Economy Act. These initial obligations consist of (i) notifying subscribers if IP addresses associated with them are reported by copyright owners in a copyright infringement report as being used to infringe copyright and (ii) providing, on an anonymous basis, copyright infringement lists to copyright owners concerning subscribers where the number of copyright infringement reports has exceeded a threshold. On top of that there is the matter of how Ofcom's costs of complying with ss 3 to 16 of the Act are to be funded.

Inevitably, the copyright owners argued that the costs of enforcement should lie as they fell, with ISPs picking up their own costs: one of the arguments being that ISPs would benefit from a reduction in copyright infringement as that would reduce stress on the networks. ISPs argued that the copyright owners were the sole beneficiaries of copyright enforcement and they should therefore bear all of the costs.

The Government has concluded that the notification costs of ISPs should be borne 75% by the copyright owners and 25% by the ISPs, and that the same would go for Ofcom costs.

ISPs will not be happy about the decision. The costs to them are anticipated to run into many millions of pounds.

Discussion paper on sharing infrastructure in connection with the rapid deployment of superfast broadband across the UK

BIS has published a discussion paper looking at the benefits and problems associated with sharing non-telecommunication utilities infrastructure so that BT and other infrastructure providers would allow the use of assets to delivery superfast broadband in remote areas. The paper notes the issues raised in previous discussions with stakeholders and sends out possible solutions. The consultation closed on 16th September 2010. The BIS will publish responses which will be used to inform future policy development.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.