Ineffectiveness of liability caps.

A great deal of lawyers' ink has been spilt crafting carefully worded liability caps in IT contracts. In EDS' case, this ink was spilt in vain as a finding that EDS had made fraudulent misrepresentations allowed BSkyB to claim over £700 million and to circumvent a £30 million cap in the contract between the parties. Interim damages of £270 million have so far been awarded.

Not an ideal start...

At the turn of the millennium, BSkyB invited companies to tender for a £50 million contract to design, build, manage, implement and integrate a new customer relationship management system. EDS was appointed in July 2000 and work commenced shortly afterwards pursuant to a letter of intent.

From this point onwards, the project did not go as BSkyB had hoped and it expressed early concerns as to whether EDS could implement the project within the promised timescales. EDS provided a revised programme and the parties entered into what became known as the "Prime Contract". Continued poor performance led to a renegotiation in 2001 and, subsequently, to BSkyB terminating the contract and taking over from EDS in March 2002.

Rather than costing £50 million and going live in the summer of 2001, the final stages of the project were not completed until March 2006, at a cost of £256 million.

BSkyB's allegations

BSkyB pleaded its case in three ways:

  • fraudulent misrepresentation inducing BSkyB into selecting EDS for the work;
  • negligent misrepresentation during the 2001 renegotiation, inducing BSkyB into continuing with EDS; and
  • "repudiatory" breach resulting from EDS' failure to exercise reasonable skill and care or conform to good industry practice.

Allegation 1: fraudulent misrepresentation

Any contract which seeks to exclude or restrict liability for misrepresentation must satisfy the test of reasonableness set out in the Unfair Contract Terms Act 1977. The courts have held that it is never reasonable to exclude liability for fraud (Thomas Witter Ltd v TBP Industries Ltd [1992] Q.B. 600) and therefore liability caps in a contract will not apply to any claim for fraudulent misrepresentation.

In order to establish fraudulent misrepresentation, a claimant must demonstrate that: (i) a false representation has been made knowingly or recklessly; (ii) with the intention that the claimant would act on the misrepresentation; and (iii) the misrepresentation induced the claimant to enter into the contract.

Mr Justice Ramsay held that EDS had represented that it had carried out a proper analysis of the amount of time needed to complete the project. That representation was false as there was no proper analysis and the relevant employee at EDS, Joe Galloway, knew that was the case. In making the misrepresentations, EDS intended BSkyB to enter into the letter of intent and then the Prime Contract, and BSkyB did so. Accordingly, EDS was liable to BSkyB for those misrepresentations.

Dogs and degrees

EDS' defence was significantly hindered by the fact that Joe Galloway perjured his evidence in court over a prolonged period. Amongst legal circles, the story of Galloway's MBA is now infamous.

Galloway claimed to have obtained an MBA from Concordia College, St. John in the US Virgin Islands. During cross examination, he was shown a website for Concordia College which provides online degrees for anyone who makes an application and pays the required fee. This was rather amusingly demonstrated by an application made by Mark Howard QC (BSkyB's senior counsel) for his dog "Lulu". The dog was able to obtain a degree certificate with marks which were better than those given to Galloway!

Paragraphs 195 and 196 of the judgment neatly summarise Mr Justice Ramsay's opinion of Galloway: "Joe Galloway's credibility was completely destroyed by his perjured evidence over a prolonged period... this reflects upon his propensity to be dishonest whenever he sees it in his interest, in his business dealings."

Allegation 2: negligent misrepresentation

The finding of fraudulent misrepresentation dealt a fatal blow to EDS, but Mr Justice Ramsay went on to consider the alternative claims put by BSkyB: negligent misrepresentation and breach of contract.

The judge held that EDS had made negligent misrepresentations prior to the 2001 renegotiation inducing BSkyB to stay with EDS. He also concluded that the entire agreement clause did not preclude BSkyB from recovering for negligent misrepresentation.

While the clause ensured that prior representations were superseded and did not become terms of the contract, they were not withdrawn for all purposes and EDS therefore remained liable for negligent misrepresentation. A statement of non-reliance or an express waiver of extra-contractual remedies would have been required to achieve that object.

Allegation 3: breach of contract

If a breach is so serious that it goes to the root of the contract or one party evinces an intention no longer to be bound by the terms of the contract, there will be a repudiatory breach, entitling the innocent party to treat the contract as ended.

BSkyB argued that, by repeatedly failing to meet contract milestones and losing control of the budget, EDS was either incapable of carrying out, or had no intention of being bound by, the terms of the Prime Contract. By taking over the contract in 2002, BSkyB said it had accepted EDS' repudiation.

Mr Justice Ramsay agreed that EDS had been in breach of the Prime Contract; however, he held that these breaches mainly related to delayed performance and were not serious enough to amount to repudiation.

This finding demonstrates the difficulty of proving that a breach is so serious that it constitutes a repudiatory breach. Therefore, if it is envisaged that certain breaches (for example, missing milestone dates) would be so serious that they should lead to an immediate termination right for the customer, this position should be expressly set out in the contract.

Some conclusions

This case has a number of lessons for lawyers involved in documenting contracts, but it also has lessons for both suppliers and customers.

For suppliers, the case points to a need for additional training as to the consequences of misrepresentations during the course of negotiation. Ensuring that representations are capable of being substantiated will be an important part of the training.

For customers, while BSkyB was of course successful in its claim, the case suggests the need for increased scrutiny of the validity of suppliers' statements about their capabilities.

Finally, while IT suppliers may be concerned that this case will open the floodgates for claims from customers seeking to circumvent liability caps, we believe that it is unlikely that there will be any increase in the proportion of successful cases. Fraudulent misrepresentation cases are rare because of the heavy burden of proof on the claimant, and the BSkyB case does nothing to alter this situation. On the other hand, it does serve as a powerful reminder of how sales incentives can drive unethical behaviour on the part of suppliers.

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.