Key Points
- Limitations of liability which are set too low will be unenforceable. What is too low will vary from case to case, but the level of insurance cover available is a critical factor.
- Suppliers should check (and if, necessary, rewrite) their existing standard terms, and develop a clear strategy in relation to limitations and liability.
- Software is now classified as goods. It therefore has to be of "satisfactory quality" - a more stringent test than the previous "reasonable skill and care".
PLANNING FOR THE DOWNSIDE - ST ALBANS v. ICL
Background - the facts
In 1989, ICL supplied St Albans City Council with a software package for calculating the community charge. The software contained an error which resulted in the Council collecting too little community charge from charge-payers for the year in question. The Council sued ICL for damages of £1.3 million, comprising two elements (plus interest): £484,000 in non-collected amounts from charge payers; and £685,000 in irrecoverable levies paid by St Albans to the Hertfordshire County Council as a result of the error.
In the High Court, ICL accepted that a software error had occurred. However, they tried to rely on a limitation of liability clause in the contract under which ICL's liability was capped at £100,000.
The High Court held that ICL were in breach of contract for supplying defective software. The Court held that St Albans were dealing with ICL on ICL's "standard terms of business" and therefore that the Unfair Contract Terms Act 1977 (UCTA) applied to the limitation of liability clause on which ICL were seeking to rely. The High Court then went on to decide that the clause was unreasonable, by setting the cap too low, and therefore unenforceable. ICL was liable to St Albans for the entire claim of £1.3 million
ICL took the case to the Court of Appeal. The CA on 26 July 1996 unanimously upheld the main findings of the High Court. There was some consolation for ICL, however, because the CA found that the High Court had allowed St Albans to recover too much by way of damages. The £484,000 which St Albans had not collected from charge-payers because of the miscalculations caused by the software error, could be recovered from charge payers in the subsequent year. It was therefore held that ICL should not be liable for that sum.
Background - The Law
Standard Terms of Business. UCTA states that limitations of liability will be subject to the test of reasonableness in two situations:
- in consumer contracts;
- in business-to business contracts, if the limitations form part of standard terms of business.
The Court of Appeal reaffirmed the High Court finding that St Albans were dealing with ICL on ICL's standard terms of business. The fact that St Albans had raised concerns over the limitation of liability clause, in last minute negotiations, was not sufficient to change this position. The St Albans case follows a trend of cases which suggest that mere negotiation is insufficient to change the nature of otherwise standard terms to non-standard: to become a non-standard term of business, there must be a substantial change in the relevant clause.
Reasonableness. UCTA sets out a number of factors which are to be considered in deciding whether an exclusion of liability is reasonable or not. These include the relative strength of the parties' bargaining positions, the resources available to the parties and the extent to which the supplier can obtain insurance: of these, the latter is often the most critical. For example, the High Court was critically influenced by the fact that ICL has insurance cover of up to £50 million.
Software as "goods": The CA introduced a new element into the decision, by holding that the supply of software constituted the supply of "goods", and therefore as a matter of law the "fitness for its purpose/satisfactory quality" tests applied to the software. Contract law distinguishes between services and goods. Services have to meet a standard of "reasonable skill and care", whereas goods have to be of "satisfactory quality" and "fit for purpose". The "skill and care" standard is lower because it relates only to the quality of the effort, not the quality of the final product.
By re-classifying software as goods, the CA has effectively increased the standards with which software must comply. Any exclusion or limitation of that standard also be subject to the test of reasonableness.
Lessons to be learnt
The CA's confirmation that ICL's limitation of liability clause was unreasonable is the most important outcome of the case, though, in practice, the CA would have found it difficult to re-examine the High Court's conclusions on this issue. Although every case must be decided on its facts, the St Albans decision does underline the importance of having a coherent strategy in relation to exclusions and limitations of liability. We set out our recommendations below.
Recommendations for Suppliers
- Review limitation and exclusion clauses in your standard form contracts, in the light of all the relevant commercial circumstances including in particular the amount and type of your insurance cover. Also take account of the resources of the customers with whom you are typically dealing, relative bargaining strength, and overall risk involved in the project or service.
- Draw up internal position papers for your sales teams on liability limits for their routine use, which can also be produced in court in the event of a dispute, to provide objective reasoning behind your choice of figures for liability caps - don't pick figures arbitrarily.
- Keep internal attendance notes of meaningful liability negotiations with your customers.
- Consider offering a range of contract prices depending on the extent of liability you are willing to accept.
- Don't assume that the "reasonableness test" under UCTA does not apply, just because a client has raised a concern over a standard clause in your contract. UCTA will continue to apply unless there has been a substantial amendment to the clause in question.
- Expect an increased amount of challenges by business customers to the liability exclusions and restrictions in your standard supply and licence contracts. This is not necessarily a bad thing.The more your standard terms are challenged, the less likely they are to be standard. Change them enough, and the UCTA reasonableness test will not apply.
Recommendation to Customers
- Don't accept standard supplier liability caps at face value - if necessary raise enforceability and reasonableness issues.
- Leaving onerous supplier clauses untouched in the hope that they will be found unreasonable is a viable but high-risk strategy. Taking suppliers to Court over their contract is a very unattractive proposition. IT litigation remains costly, time consuming, uncertain, stressful and must be regarded as an absolute last resort. Commercial negotiation, compromise, and dispute resolution remain the favoured options.
- Minimise your losses if there is a software malfunction by documenting the actions you have taken in order to do so, and keep careful track (including written records) of how much money you have spent as a result.
For further advice please contact us.
This newsletter is correct to the best of our knowledge and belief at the time of going to press. It is, however, written as a general guide, so it is recommended that specific professional advice is sought before any action is taken.
Garretts is authorised by the Law Society of England and Wales to carry on investment business.
