For tech lawyers like me and many readers of this blog, it’s a rare treat when a Canadian court construes an IT contract and opines on clauses we see in agreements all the time. The case IT lawyers will want to read is Atos v Sapient, 2016 ONSC 6852
This case involved a contract dispute between the prime contractor Sapient and its subcontractor Siemens (now Atos). Here are some legal nuggets you might want to think about in your next IT contracts.
What does “material breach” mean in a contract that permits termination for material breach? It does not, according to the court, have the same meaning as the common law concept of repudiation or fundamental breach that connotes a breach that goes to the root of the contract. Rather, it is one “that has material consequences but ‘does not rise to the level of one that has deprived the innocent party of substantially the whole benefit of the contract’”. It is a term that has to be “carefully construed in light of the particular doctrinal or contractual context in which the terms are being employed.” In the case of a breach by a subcontractor, the court held, after reviewing the contract in issue, it is “a non-trivial breach that affects or may affect” the prime contractors’ “ability to perform its obligations under the Prime Contract in a material respect”.
Many IT contract give a party a right to terminate a contract at its discretion for a failure to meet a key milestone deadline. While the right exists, it is, according to the court, subject to a duty to exercise that right “in good faith”.
Most IT contracts contain disclaimers and limitations of liability. One often sees such contracts limiting damages only to “direct damages” and an express disclaimer of consequential damages including loss of profits. An example is the following from the subcontract in issue in the case:
Section 18.6 of the Subcontract, which is entitled Limitation of Liability, provides, in part:
18.6.1 SUBJECT TO SECTION 18.6.2, NOTWITHSTANDING ANYTHING TO THE CONTRARY HEREIN, EACH OF SUBCONTRACTOR AND SAPIENT WILL BE LIABLE TO THE OTHER WITH RESECT TO THIS AGREEMENT AND ANY OTHER OBLIGATIONS RELATED THERETO ONLY FOR DIRECT DAMAGES AND FOR AN AMOUNT THAT WILL NOT EXCEED, IN THE AGGREGATE…
FOR GREATER CERTAINTY, SUBJECT TO SECTION 18.6.2, NEITHER SUBCONTRACTOR NOR SAPIENT WILL BE LIABLE TO THE OTHER TO THE OTHER FOR INDIRECT, SPECIAL, CONSEQUENTIAL OR PUNITIVE DAMAGES OR FOR LOSS OF PROFITS (COLLECTIVELY, “EXCLUDED DAMAGES”), EVEN IF THE PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES….
18.6.3 THIS SECTION 18.6 WILL APPLY IRRESPECTIVE OF THE NATURE OF THE CAUSE OF ACTION, DEMAND OR CLAIM, INCLUDING BUT NOT LIMITED TO, BREACH OF CONTRACT (INCLUDING FUNDAMENTAL BREACH), NEGLIGENCE, TORT OR ANY OTHER LEGAL THEORY, AND WILL SURVIVE A FUNDAMENTAL BREACH OR BREACHES AND/OR FAILURE OF ESSENTIAL PURPOSE OF THIS AGREEMENT OR OF ANY REMEDY CONTAINED HEREIN.
Does such a clause prevent the recovery of the expected profit of a subcontractor when its subcontract is found by a court to have been improperly terminated (as in this case)? According to the court, no. The court gave the following reasons which should be read carefully by IT lawyers.
In my view, when the words in Section 18.6.1 are read both on their own and in the context of the Subcontract as a whole, the limitation of liability set out in Section 18.6.1 does not apply to Siemens damage claim for loss of profits in respect of AMS…
Turning first to the wording of Section 18.6, the wording in Section 18.6.1, which limits damages to direct damages only, includes loss of profits under the Subcontract. As previously discussed, expectation damages, which are direct damages, include loss of profits.
Section 18.6.1 goes on, however, “for greater certainty” to provide that neither Siemens nor Sapient will be liable to the other for “indirect, special, consequential or punitive damages or for loss of profits (collectively, ‘Excluded Damages’), even if the party has been advised of the possibility of such damages.”
Given the above grouping and inclusion of “loss of profits” as Excluded Damages along with “indirect, special and consequential damages”, in my view the reference to “loss of profits” in Section 18.6.1 refers to consequential or indirect lost profits, i.e., a breach that causes either Siemens or Sapient to lose profit from other work forgone as a result of the breach. Consequential lost profits do not include profits under the Subcontract but rather are indirect losses which are only recoverable when they are foreseeable or communicated to the defendant: Hadley v. Baxendale (1854), 9 Exch. 341, 156 E.R. 145 (Eng. Ex. Div.) at para. 3. My conclusion that the provision of “loss of profits” in Excluded Damages relates to consequential or indirect profits is further confirmed by the concluding words of the paragraph which provide: “even if the party has been advised of the possibility of such damages.” That language is in accordance with the Hadley recovery principle for consequential damages.
In my view, the above interpretation of “loss of profits” in s. 16.1 is also confirmed when considering the context of the Subcontract. The AMS portion of the Subcontract is a fixed price commercial contract for services. It is reasonable to assume that parties who enter into such a contract would rely on the fact that they would receive the loss of profit component of the price in the event of a breach…
Further, there is no evidence surrounding the formation of the contract that would support a finding that it was the intention of the parties at the outset of the Subcontract that the limitation of liability clause would apply to prevent the recovery of loss of profits in the event of a breach of the Subcontract.
For the above reasons, therefore, I conclude as a matter of interpretation that the limitation of liability clause in Section 18.6 of the Subcontract does not apply to Siemens’ claim for loss of profits arising from Sapient’s breach of the AMS portion of the Subcontract. The claim for lost profits is a direct damage