The broad (and unintended?) effect of a loss of profit exclusion
CIS v IBM (High Court) [2021]
Exclusions of liability for ‘loss of profit’ are routine and, historically at least, relatively uncontentious. Sellers / service providers typically included the exclusion and buyers were happy to accept it on the basis that its impact was thought to be limited. That may have changed completely as the result of this decision
Facts:
As reported previously, CIS entered into a contract with IBM for the implementation of a new IT solution to support their insurance business together with ongoing services and support for a ten-year term. IBM was held to be in breach of the Agreement. The court then had to consider the damages that CIS was entitled to. CIS brought a claim based upon wasted expenditure. The size of the claim was circa £128 million. CIS also presented an alternative claim of £27.2 million for additional expenditure based on the delays and the failure of IBM to keep CIS properly informed.
Questions were raised as to the impact of the contractual exclusion clause which stated “Neither party shall be liable … for any Losses … which are indirect or consequential Losses, or for loss of profit, revenue, savings (including anticipated savings), goodwill, reputation (in all cases whether direct or indirect)”.
‘Losses’ were defined as “All losses, liabilities, damages, costs and expenses including reasonable legal fees on a solicitor/client basis and disbursements and reasonable costs of investigation, litigation, settlement, judgment, interest.”
Decision:
The court reviewed the basis upon which damages may be claimed for breach of contract, referencing in particular, the ‘expectation basis’, (the additional amount of money that the claimant would require to achieve the financial value of the expected contractual benefit, such as lost profits, the cost of reinstatement or diminution in value) and the ‘reliance basis’ (expenditure incurred in reliance on the defendant’s promise, such as sums paid to the defendant or other wasted costs).
The court said the starting point is to identify the contractual benefit lost as a result of IBM’s breach of contract. According to the court, the loss of the bargain suffered by CIS as a result of IBM’s breach comprised the savings, revenues and profits that would have been achieved had the IT solution been successfully implemented. CIS’s claim for wasted expenditure was held to be excluded on the basis that it represented a claim for ‘loss of profit’ by another name. This is likely to be very controversial. In coming to this conclusion, the judge distinguished the case of Royal Devon & Exeter NHS Trust v ATOS (2017) in which the judge had found that “the rebuttable presumption that the value of the loss of the functioning computer system would be at least equal to the claimant's expenditure, "did not transform" the claim for loss of the system into a claim for loss of additional benefits, such as profits, that would flow from use of the system. The defendant had wrongly assumed that any contractual benefit which was presumed to at least equal the value of the claimant's expenditure necessarily represented profits, revenues or savings”. However, the judge in that case went on to say that the Devon case was different from most commercial cases because the benefits expected were non-pecuniary. This seems to have left the door ajar for the finding in this case.
As a result, the CIS claim for £128million of wasted expenditure was disallowed. This included the £34million CIS spent on the project with IBM. We would suggest that this may very well cause customers to reassess the acceptability of supplier exclusions of liability for loss of profit as historically drafted. We would not be at all surprised if this element of the judgment is appealed. Can such payments really properly be described as ‘lost profits’?
There was no discussion as to whether any such exclusion was unreasonable under UCTA.
CIS’s funding for the project (through the creation of a bond or interest bearing loan) was regarded as a direct cost incurred by CIS. The bond interest and transaction fees were properly included in the claim for wasted expenditure but since the claim for wasted expenditure was held to be excluded by the contract terms in any event this made no difference to the damages ultimately awarded.
CIS was held entitled to recover only £15.9 million. This was in respect of costs incurred prior to termination which would not have been incurred by CIS had IBM achieved the contractual milestones on the due dates and/or properly informed CIS as to the true state of the project as it progressed. The largest element of the allowed claim was in respect of additional resource costs in respect of building and testing software and assisting with data migration, architecture, staffing an office and business readiness activities.
Points to Note:
- The judge referenced a well-known cardinal rule on the award of damages “Damages for breach of contract are compensatory; the innocent party is to be placed, so far as money can do, in the same situation as if the contract had been performed”. That is the start point. However, contracts represent a balance between risk and reward for both parties. Customers are entitled to expect to be reasonably compensated in the event of a breach. Likewise, suppliers are entitled to reasonably limit their potential exposure to damages.
- It would seem that in this case, the contractual exclusion clauses have been given something of a ‘strained’ and probably unintentional interpretation. Given that IBM accepted that the amounts paid to it in relation to Release 1 and Release 2 have largely been wasted and that the judge found that “the costs of the IT solution were wasted in their entirety” it does seem strange that a ‘loss of profits’ exclusion would be held to defeat claims for wasted expenditure. Can it really be said that CIS were claiming overwhelmingly for anticipated contractual benefits or ‘profits’?
- It remains to be seen whether CIS appeal. In the meantime, purchasers of IT systems and services would probably be well advised to adopt the wording used in some UK public sector contracts (set out in full below) by way of a qualification to exclusions of liability for indirect loss, consequential loss and loss of profit.
- It has also been suggested that the judgment may affect whether a customer decides to terminate a contract (as CIS did) or perseveres with the original procurement albeit incurring additional costs. In the latter case, the original contractual exclusion clauses may have less of an impact on the damages recovered. This would need careful consideration.
- “Subject to Clause X (Financial Limits), and notwithstanding Clause Y (Non-recoverable Losses such as exclusions of indirect, consequential loss and loss of profit), the Supplier acknowledges that the Customer may recover from the Supplier the following Losses incurred by the Customer to the extent that they arise as a result of a Default by the Supplier:
any additional operational and/or administrative costs and expenses incurred by the Customer, including costs relating to time spent by or on behalf of the Customer in dealing with the consequences of the Default;
any wasted expenditure or charges;
the additional cost of procuring Replacement Services for the remainder of the Call Off Contract Period and/or replacement Deliverables”.