Why you need a good information technology lawyer for complex IT agreements: CIS v IBM

technology lawyer

If you are an information technology lawyer you will want to read the recent decision from the U.K., CIS General Insurance Ltd v IBM United Kingdom Ltd [2021] EWHC 347 (TCC) (19 February 2021). The case resulted from what the court described as “a disastrous IT project” for a build and run insurance system project in which IBM wrongfully terminated the contract to avoid mounting losses. The case is replete with abject lessons for information technology lawyers who draft and negotiate or litigate complex IT agreements.

This 754 paragraph long decision has much to learn from. I will concentrate on the interpretation of clauses that we information technology lawyers routinely negotiate in IT agreements.

Background

Justice O’Farrell described the case as essentially one concerning “a claim for wasted costs and damages arising out of the termination of a contract for a new information technology system.” The claimant (“CISGIL”) was is in the underwriting and distribution of general insurance products. As a result of a corporate reorganization it need to acquire and implement a new IT solution for its business (“Project Cobalt”). It entered into a build and run contract with IBM. The IT contract comprised a Master Services Agreement (“the MSA” or the “IT agreement”), an Implementation Statement of Work (“the Implementation SOW”) and a Managed Service Statement of Work (“Managed Service SOW”). It was major transaction. The cost of supply and implementation of the new system was £50.2 million. The cost of the management services to be provided over a period of ten years from implementation of the system was estimated to be £125.6 million.

As frequently happens, IBM partnered with a material subcontractor, the Innovation Group (“IG”), to supply software and services for the insurance platform using proprietary software called “Insurer Suite”. As a material subcontractor IBM relied extensively on IG to make enhancements to its platform and to meet the timing milestones in the MSA for the Agile methodology development project.

To make a long story short, and at the risk of oversimplifying what happened, IG materially breached its subcontract with IBM. It was late; the code was buggy; there were so many blockers (critical key defects) that UAT (user acceptance testing) had to be suspended. IBM lost confidence in IG and CISGIL lost confidence in IBM’s ability to meet it contractual commitments. CISGIL retained lawyers and sent IBM a formal notice of breach, which breaches were not cured by IBM. But, it didn’t terminate the agreement for breach.

Things came to a head when IBM submitted an invoice, the AG5 invoice, for payment to CISGIL. The invoice was rejected and CISGIL notified IBM that it would not pay that invoice and that it reserved the right to set off from all future invoices damages resulting from IBM’s breaches of contract.[1] IBM then served a notice purporting to terminate the MSA. CISGIL informed IBM it considered the termination notice to be invalid and a repudiation of the IT agreement between the parties, which repudiation was accepted by CISGIL.

IBM’s termination of the MSA was, as the judge described it, a “high-risk strategy” “used to bring the project to an end”. The project was a disaster; continuing with it would have resulted in substantial additional losses to IBM. IBM could limit its financial exposure by terminating the agreement. Even if it turned out to be a wrongful termination, IBM could rely on the IT agreement’s limitations and disclaimers of liability to limit its downside financial exposure. In other words, even if IBM had to pay damages occasioned by a wrongful termination, it might still be a better strategy than finishing the project.[2] The judge summarized IBM’s position on the termination as follows:

IBM’s position is that as at termination, IG was significantly behind programme, particularly in defect correction, and substantial additional resources would be required to correct the deficiencies in the software but it would have been possible to deliver the IT solution. However, CISGIL’s refusal to pay the AG5 milestone was the tip of the iceberg. It made clear to IBM that not only would the invoice not be paid but that no further invoices would be paid and IBM would be expected to complete the project without recompense, after which CISGIL would claim its losses arising out of the delays. IBM was not prepared to continue the project on that basis.

Project Cobalt was a failure. The parties abandoned the unfinished project that had consumed costs to CISGIL in excess of £120 million. This left CISGIL with an uncompleted system offering little or no value and substantial financial losses. IBM also likely had significant losses on the project.

Legal Issues

Did IBM have the right to terminate the MSA?

A central issue in the case was whether IBM had the right terminate the MSA for non-payment or whether its termination was wrongful. This issue turned on the interpretation of a number of clauses in the agreement good information technology lawyers negotiate all the time.

IBM had a right to terminate the IT agreement for failure to pay undisputed invoices exceeding a specified amount. The clause and related terms, which are fairly typical in IT agreements, read as follows:

Clause 26.7 “The Supplier shall have the right to serve on the Customer a written notice (Final Notice) if the Customer has failed to pay undisputed invoiced amounts which in aggregate exceed £1 million (one million pounds sterling) and which have been due and payable for a period in excess of forty five (45) days. Any such Final Notice shall itemise the undisputed invoiced amounts to which it relates and be addressed for the attention of The Chief Financial Officer of the Customer stating the Supplier’s intention to terminate this Agreement and specifically referring to this clause 26.7. If the Customer fails to pay such undisputed invoiced amounts fifteen (15) Business Days of receipt of the Final Notice the Supplier may terminate this Agreement immediately.”

Schedule 5 A to the IT agreement also set out the invoicing and payment obligations of the parties including the process for disputing invoices, again in fairly typical terms (other than the very short 7 day period for disputing invoices), as follows (in part):

11.4       Unless otherwise agreed by the parties, each Supplier invoice shall…

(b)     quote the relevant Statement of Work identifier and the unique Customer purchase order number;

11.7       Unless the Customer disputes an invoice in good faith in accordance with paragraphs 11.11 and 11.12 of this schedule 5 (Charges), the Customer shall pay correctly prepared invoices properly submitted in relation to payments to be made under this Agreement within seven (7) Business Days of receipt.

11.10     An invoice from the Supplier in relation to any part of the Charges is deemed not to have been correctly prepared if the Supplier has failed, in relation to that invoice and the supporting relevant documentation to be provided in relation to that invoice, to meet the relevant requirements for an invoice as set out in this schedule 5 (Charges).

11.11     If, at any time, the Customer acting in good faith disputes an invoice or an amount shown in an invoice delivered by the Supplier, the Customer shall pay the undisputed amount (if any) of the invoice within the period required under paragraph 11.7 above. The Customer shall within seven (7) Business Days of receipt of an invoice notify the Supplier in writing if it disputes any element of the invoice with details of the amounts (Disputed Amount) and reasons for disputing the relevant part of the invoice.

11.12     Provided the Customer has given the notice in paragraph 11.11, the Customer may withhold payment of, and meet with the Supplier to discuss, the Disputed Amount, and will request at such meeting any additional details that it may need to verify the accuracy of the Disputed Amount within ten (10) Business Days of notifying the Supplier of the Disputed Amount. The Supplier shall comply with each such request from the Customer for additional information. If within (10) Business Days after the date on which the Customer has received the additional details requested from the Supplier, the Disputed Amount has not been agreed, then the Customer and the Supplier shall resolve the matter in accordance with the dispute resolution process set out in schedule 19 (Dispute Resolution) of this Agreement.”

The payment clause had a very short 7 day period to dispute an invoice. This is shorter than what is typical in a complex IT agreement. Further, the MSA did not give CISGIL any right to withhold payment on the achievement of milestones if IBM was otherwise in significant breach of the MSA.

CISGIL raised various reasons why it was not obligated to pay the invoice.

Non-Approval of Payment Milestone

CISGIL argued it did not approve the milestone that triggered the obligation to pay the invoice. However, even though IBM was otherwise in breach of the agreement that milestone had been achieved. Accordingly, the court found that CISGIL could not rely on its own absence of approval to withhold payment.

I accept IBM’s submission that CISGIL can’t rely on the absence of approval to withhold payment of the AG5 milestone where such approval was wrongfully withheld. In Alghussein Establishment v Eton College [1988] 1 WLR 587 the House of Lords held that the appellant tenant was not entitled to rely on its own failure to carry out the development of property to enforce a provision in the agreement requiring the respondent landlord to grant a lease of the property. Having considered the authorities on this point, Lord Jauncey stated at p.594C:

“Although the authorities to which I have already referred involve cases of avoidance the clear theme running through them is that no man can take advantage of his own wrong. There was nothing in any of them to suggest that the foregoing proposition was limited to cases where the parties in breach were seeking to avoid the contract and I can see no reason for so limiting it. A party who seeks to obtain a benefit under a continuing contract is just as much taking advantage of his own wrong as a party who relies on his breach to avoid a contract and thereby escape his obligations.”

CISGIL was obliged to approve the achievement of the AG5 milestone in January 2017. That obligation was owed to IBM under the terms of the MSA, the Implementation SOW and the Roadmap. In breach of its obligation, CISGIL failed to approve the milestone. CISGIL is not entitled to benefit from its own default in seeking to avoid payment by asserting the invalidity of the AG5 invoice based on the absence of approval.

For the above reasons, I reject CISGIL’s case that the Application Gate 5 milestone was not due in January 2017 because milestones IMP-021 to IMP-029 had not been achieved in accordance with the terms of the MSA and the Implementation SOW or because formal approval of the milestone was not given by CISGIL.

Was the invoice disputed in good faith?

CISGIL argued that IBM’s invoice did not contain the purchase order (PO) number required by the IT agreement and it had disputed the invoice in good faith in accordance with the payment terms.

Payment dispute clauses are common in IT agreements and are generally enforced by the courts.[3] The court found that CISGIL disputed the invoice in a timely manner as required by the payment terms.

IBM argued, however, that the dispute was not in good faith as CISGIL took a deliberate decision not to provide IBM with the PO it required to render the invoice and did not forewarn IBM that it would justify its refusal to pay by the absence of the PO.  The court found for CISGIL holding it did not act in bad faith stating:

Mr Summerfield of CISGIL admitted that he took a deliberate decision to withhold the purchase order number for application gate 5 because he did not consider that IBM was entitled to payment, having failed to achieve the Release 1 and Release 2 Go Live milestones. As set out above, that was wrong. IBM was entitled to the purchase order for the AG5 milestone because payment was not conditional on progress of the project. However, CISGIL’s case on construction of the Roadmap, the relevant provisions of the MSA and the Implementation SOW against the relevant factual matrix, was worthy of scrutiny and could not be considered unarguable. On that basis, it was a position that was not so unreasonable that it amounted to bad faith.

Fourthly, there was no contractual obligation on CISGIL to forewarn IBM of its decision to withhold the purchase order for the application gate 5 milestone, to justify its decision to withhold the purchase order, or to activate the dispute resolution procedure. IBM was well aware that CISGIL did not intend to pay the AG5 milestone, as evidenced by Jonathan Smith’s internal email. The purchase order had been requested and had not been issued. Both parties knew that the AG5 milestone payment was controversial; both parties had the opportunity, but failed, to use the dispute resolution procedure in respect of the matter.

For the above reasons, I find that CISGIL validly disputed the AG5 invoice for the purpose of paragraph 11.11 of Schedule 5, entitling it to withhold payment of the same.

The court found that CISGIL did not act in bad faith. It made no express finding that it had acted in good faith. However, given the reasons of the trial judge it seems likely that is what she intended.

Under Canadian law, parties have an obligation to exercise all contractual rights in good faith. The duty is breached where the right is exercised unreasonably such as in a manner unconnected to the purposes underlying the term or where a right is exercised in an arbitrary or capricious manner.[4] IBM claimed that CISGIL changed its mind about the project and decided that it no longer wanted the new system or to invest in a capital intensive business. Had IBM been able to make this claim stick that may, at least under Canadian law, have been an important consideration for the judge to consider, among the others, as to whether CISGIL had acted in good faith in withholding the PO and in not making the payments that was due. Under Canadian law, parties also have a duty of honest performance in their contractual dealings with counterparties.[5] If IBM had been able to prove that CISGIL had mislead it as to whether it would issue the PO or pay the invoice, at least under Canadian law, this may have breached this contractual obligation. But this duty did not require CISGIL to disclose to IBM it had intended to withhold payment because of the absence of a PO.

Set-off and good faith dispute

CISGIL claimed it was entitled to set off its claim for unliquidated damages against IBM against any sum payable under the invoice by way of equitable set-off. Under general contract law principles, unless otherwise excluded by the contract, a party is entitled in equity to set off mutual debts and certain other claims if there is a close enough relationship between the dealings and transactions which gave rise to the respective claims.[6]

The court found that it was “reasonably clear that, as a matter of principle, CISGIL’s claims against IBM for culpable delay in failing to achieve key milestones… gave rise to an equitable set-off.”

IBM argued, however, that CISGIL was not entitled to exercise its set-off right because set-off was not raised when CISGIL disputed the invoice within the allowed 7 day period.

It also claimed the set-off right was excluded by the IT agreement because the clause that dealt with disputing invoices did not mention set-off of claims. Under contract law, clear words are required to exclude the equitable right of set-off.[7] Heavily negotiated IT agreements often contain a clause either permitting or precluding set-off rights. The MSA had no such clause.

The court rejected IBM’s argument that the set-off right was precluded drawing a distinction between a clause that excludes set off rights and a contractual provision that makes the exercise of the right conditional on notice. It found for CISGIL on this point. However, the court found that the right was not raised within the 7 day period required to dispute invoices in good faith. Accordingly, CISGIL could not raise set-off as a ground for non-payment of the invoice.[8]

In the result, IBM was not entitled to exercise any right of termination under the IT agreement because CISGIL disputed the applicable invoice in good faith within 7 days of its receipt. In those circumstances, the purported termination amounted to repudiatory breach, which CISGIL was entitled to accept.

What is not clear from the reasons in the decision is why CISGIL took the high risk strategy of giving IBM an opportunity to escape from the agreement by not paying this particular invoice. The court found as a fact that “both parties were resigned to abandonment of the project. Both parties retained legal teams and tried to manoeuvre themselves into a position where they could extricate themselves from the MSA with minimum damage.” But, CISGIL had a right to terminate the IT agreement for a material breach of the IT agreement which was incapable of remedy or which, if capable of remedy, had not been remedied within 30 days of receipt of written notice from CISGIL specifying the breach and requiring it to be remedied.[9] As IBM appeared to be in material breach, one wonders if CISGIL would have been on a more solid legal footing by terminating the MSA based on IBM’s material breaches rather than by disputing this invoice and making it’s good faith a key issue in the case.

Whether IBM was Relieved of Liability for not Achieving Milestones

One of the significant risks in major software/infrastructure development IT agreements is delay. At common law, unless excluded by contract, the “prevention principle” applies to give a contractor an extended time to complete its work if the hiring party was responsible for causing the delay.[10] However, the principle only applies if the contractor can establish that delays rendered it impossible or impractical to meet contractual obligations.[11]

Many IT agreements negotiated by good information technology lawyers expressly limit delay claims with clauses that require suppliers to provide notice of potential claims and to limit the delay claim remedies. The MSA had such clauses:

“9.4       The Supplier shall not be liable for any delay or failure to perform any of its obligations under this Agreement or any SOW if and to the extent that:

(a)     such delay or failure to perform is caused directly by a failure or delay by the Customer or any member of the Customer Group to perform the Customer Responsibilities in accordance with this Agreement that is material or has a material impact;

(b)     the Supplier has promptly notified the Customer when it reasonably believed that any failure by the Customer to perform the Customer Responsibilities in accordance with this Agreement has or is likely to have a detrimental effect on the Supplier’s ability to perform its obligations; and

(c)     despite having done all that is reasonable to perform the Services and provide any Deliverables in such circumstances, the Supplier has been unable to do so…

9.5         The parties agree that in the circumstances set out in clause 9.4, the Supplier will be afforded a reasonable extension of time to perform its relevant obligations, including any obligations relating to subsequent dependent Milestones that are directly affected by the failure or delay, any such extension not to exceed the period of delay caused by the failure or delay and being agreed by the parties in accordance with the Change Control Procedure.”

IBM claimed that CISGIL was responsible for delays. However, IBM failed to provide the notice required under clause 9.4 and was thus disentitled to the relief provided by the clause.

IBM pleaded an alternative case that pursuant to an implied term, IBM would not be liable for late achievement or non-achievement of the milestones where such late or non-achievement was caused by CISGIL. As under Canadian law, there is a stringent test for implying additional terms into a contract and such a term cannot be implied if it would conflict with an express contractual term.[12] The court concluded that the term could not be implied because it would conflict with the express contractual regime set out in clauses 9.4 and 9.5:

Applying that test to this case, IBM has not established an implied term exonerating it from liability for late achievement or non-achievement of the milestones where such late or non-achievement was caused by CISGIL. Although such an implied term might be reasonable and equitable, it is always open to the parties to allocate risk in a commercial contract. Such a term is not necessary to provide this contract with commercial or practical coherence and would contradict the express requirements for notice of delay to be given as a pre-condition to any relief. The above contractual provisions set out a complete code for the dates by which IBM was obliged to achieve the Milestone Dates, the circumstances in which, and the extent to which, it would be relieved from such obligations. There is simply no necessity to imply a term as alleged.

On the facts, the court also found that the delays were caused by IBM.

Breach of the reporting obligations

Many well drafted IT agreements contain detailed reporting obligations on the supplier. These terms are critical for successful contract governance. They enable customers to know if the contract is going off the rails, and enables them to manage delays and project problems. It can also enable them to make damages claims for costs and expenses that could have been averted had the problems been reported.

The IT agreement contained detailed reporting obligations including an obligation on IBM to notify CISGIL “when it becomes aware of any development which may have a material impact on the Supplier’s ability to provide the Services effectively and in accordance” with certain clauses of the agreement.[13]

CISGIL claimed that IBM failed to manage the programme and to report actual and probable future progress of the implementation of the solution with reasonable accuracy so as to enable CISGIL to plan its expenditure on its own resources and third party contractors with reasonable efficiency.

The court found “it is clear that in breach of the MSA and the Implementation SOW, IBM failed to meet the key milestones… and failed to provide accurate reports as to such delays during the project”.

CISGIL also claimed that IBM did not inform it that Insurer Suite did not provide the configurable Out of the Box solution upon which the MSA and the key milestones were predicated nor that the Insurer Suite had to be substantially rewritten or redeveloped in order to meet the requirements it had contracted for and that the key milestones were unachievable.

To make out this claim CISGIL contended that IG knew these facts (because it owned the software). CISGIL also contended that this subcontractor’s knowledge should be imputed to IBM because IBM was bound to perform its contractual obligations whether by itself or by its subcontractor. CISGIL sought to rely on a standard subcontract term contained in many IT agreements that IBM was not “relieved of any of its liabilities or obligations under this Agreement by entering into any subcontract”.[14]

The court ruled that this relatively standard subcontract term was insufficient to fix IBM with the knowledge of its subcontractor:

Clause 18.5 of the MSA imposed on IBM responsibility for the performance of its contractual obligations regardless of whether those obligations were sub-contracted to others by IBM. It did not, expressly or implicitly, impute to IBM knowledge on the part of its sub-contractors. As IBM submits, the reporting and management obligations set out in the MSA were personal to IBM. The reporting obligations were limited to matters within IBM’s actual knowledge and did not extend to matters known only to IG.

I accept IBM’s submission that the proposition that IBM is immediately fixed with its sub-contractor’s knowledge is wrong and based on a flawed assumption. CISGIL submits that if IBM had sought to implement the core insurance functionality and had not sub-contracted it to IG, IBM would inevitably have had all IG’s knowledge about Insurer Suite. Clause 18.5(a) ensures that IBM cannot avoid liability because it sub-contracted to IG and therefore did not acquire that knowledge itself. The flawed assumption is that IBM would have had IG’s knowledge about Insurer Suite. If IBM had not sub-contracted to IG, it would have had no knowledge of Insurer Suite. Almost certainly, it would have struggled to perform the MSA because it did not have the in-house knowledge and expertise to do so; hence the use of a specialist sub-contractor. But it is unrealistic to suggest that IG would have handed over its intellectual property rights in Insurer Suite to allow IBM to ‘have a go’. CISGIL’s argument is a bad point.

The court went on to dismiss this failure to report claim against IBM.

Did CISGIL have a breach of representation or warranty claim against IBM?

CISGIL had a made a separate claim against IBM in connection with a term as to whether IBM had satisfied itself as to all risk, contingencies and circumstances regarding performance of the MSA and the SOWs. It claimed that Insurer Suite was not a UK ready product that could meet CISGIL’s requirements Out of the Box with the level of configuration and customisation that had been identified pre-MSA. Insurer Suite required substantial base code development and IG did not have the resources required to meet the project timescales. It also claimed that IBM failed to ascertain the extent of the risks and take reasonable steps to satisfy itself as to the risks.

CISGIL relied on Clause 12.1(c) of the IT agreement which reads as follows:

“The Supplier warrants and represents to Customer and each member of the Customer Group that…

(c) having taken all reasonable steps (including making all appropriate inquiries and obtaining all appropriate professional and technical advice) that it has satisfied itself as to all risk, contingencies and circumstances to do with its performance of the Agreement.”

There were a number of issues associated with determining if IBM had any liability under the clause.

Could CISGIL claim for breach of any representation?

Many negotiated IT agreements contain one or more terms designed to exclude representations, warranties, and collateral warranties or other agreements not contained in the agreement from having any legal effect. For example, suppliers often press to expressly exclude pre-contractual statements and promises, such as those made in proposals or responses to RFPs or RFQs or otherwise made during the proposal submission process. They do so using so called “integration” or “entire agreement clauses”. Courts generally give effect to these  clauses if properly drafted.

Some suppliers also use a “bootstrap and suspenders” approach to excluding potentially actionable representations using “non-reliance” clauses. These clauses get customers to agree that they have not entered into agreements relying on any representations. This type of clause, which is generally enforced by courts, can be effective to prevent reliance on representations since one of the elements of a claim for misrepresentation is that a statement has been relied on.

Many customers and good information technology lawyers push back on such clauses, or at least on certain exclusions, not being willing to give up any claim for statements, promises or collateral warranties made to induce selecting the vendor and its products and services.

A third, but less common clause, is one that limits remedies for breach of any representation or warranty to be a breach of the agreement. This type of clause is designed to exclude remedies like recission that are only available for certain types of misrepresentations.

Clause 38 of the MSA contained a hybrid of these provisions which read as follows:

Each party acknowledges that in entering into this Agreement it does not rely on any representation, warranty, collateral contract or other assurance of any person (whether party to this Agreement or not) that is not set out in this Agreement or the documents specifically incorporated in it. Each party waives all rights and remedies which, but for this clause, might otherwise be available to it in respect of any such representation, warranty, collateral Agreement or other assurance. The only remedy available to any party in respect of any representation, warranty, collateral contract or other assurance that is set out in this Agreement is for breach of Agreement under the terms of this Agreement.

When dealing with CISGIL’s claim, the court gave effect to the clause noting that the “use of the word ‘represents’ doesn’t add anything to the meaning of ‘warrants’ in this context because clause 38 of the MSA is a non-reliance provision which limits each party’s remedy in respect of any representation to such remedy available for breach of contract under the terms of the MSA.” The effect of the clause, therefore, was to remove any claim CISGIL might have had for misrepresentation and recission, other than perhaps for any claims based on fraudulent misrepresentation.[15]

Construction of the warranty

CISGIL argued that clause 12.1(c) of the IT agreement imposed an obligation on IBM to take all reasonable steps to satisfy itself that IG’s software was capable of providing the IT solution within the contractual or other reasonable timescale. IBM contended that the clause was directed towards IBM satisfying itself as to the risks associated with performance of the MSA, not to provide CISGIL with comfort or a potential remedy but to preclude IBM from subsequently making claims against CISGIL, or seeking relief from its obligations, in relation to matters which should have been reasonably foreseeable to IBM. IBM submitted that the clause allocates the risk of increased time or cost as a result of adverse risks, contingencies and circumstances (which IBM should have anticipated) to IBM.

The court rejected IBM’s argument. First because the argument was inconsistent with the wording of the clause. Secondly, because the clause contained no reference to any limitation on rights or claims IBM would otherwise have. A further reason is that the MSA, like many IT agreements negotiated by good information technology lawyers, already contained a provision designed to limit IBM’s ability to claim any remedy or relief against CISGIL arising from matters it had the opportunity to investigate.[16]

Did IBM breach the warranty clause?

The court found that IBM did not breach the warranty. However, before doing so it embarked on a long analysis of what the term “all reasonable steps” meant and how the term might differ from a “best efforts” term. These terms are frequently found in IT agreements and IT lawyers often heavily negotiate whether an obligation should be worded as to take “reasonable steps”, “all reasonable steps” or “best efforts or endeavors”.

CISGIL submitted that an obligation to take “all reasonable steps” was the same as an obligation to use best endeavours. The court did “not accept that an obligation to use ‘all reasonable endeavours’ is necessarily the same as an obligation to use ‘best endeavours’, although in many cases there may be no discernible difference in practice.” According to the court:

Although an obligation to use best endeavours is likely to encompass all reasonable steps that could be taken, it might extend to more than an accumulation of moderate or sensible steps. It is conceivable that the circumstances of a particular case could require the party with such an obligation to go further, such as taking steps that were against his own financial interests, or steps that required extraordinary efforts. Such steps are unlikely to fall within the scope of a ‘reasonable endeavours’ obligation.

In the end, the court noted that although the “authorities provide helpful guidance as to meaning of the phrase ‘all reasonable steps’” this did “not obviate the need to interpret those words as part of the agreement between the parties in this case.”[17] Having reviewed the evidence in detail, the court concluded that IBM did not breach the warranty.[18]

Quantum of damages and limitation of liability Issues

Damages for missing milestones

The court found that IBM missed achieving agreed to milestones and failed to report on delays associated with the project. Those breaches caused CISGIL to incur costs it otherwise would not have spent or could have mitigated. The court held these damages were recoverable and were not excluded by any liability disclaimers in the IT agreement. CISGIL was awarded the sum of £15,887,990 in respect of these damages.[19]

IBM was entitled to payment of the AG5 invoice in the sum of £2,889,600.

Recovery of Wasted Expenses

CISGIL’s primary damage claim was for the recovery of wasted expenditures, namely, the costs incurred in respect of Project Cobalt in the sum of £128 million. These costs included amounts paid to suppliers including IBM, dual run costs, post termination costs, management fees, secondment fees, and interest fees paid for a loan taken out, at least in part, to finance the procurement of the system.

After the termination of the MSA CISGIL decided not to contract with another supplier for a replacement system. It exited the business and had no need to replace the system.

Many information technology lawyers might have assumed that, subject to applicable liability caps, such wasted expenditures would be recoverable for IBM’s wrongful termination and effective abandonment of the project. But, this is not what the judge found.

IBM argued that the claim for wasted expenditures was excluded by its damages disclaimer which disallowed recovery of damages for loss of profits, revenue, and savings. Clause 23.3 of the IT agreement had the following disclaimer of liability:

Subject to clause 23.2 and 23.4, neither party shall be liable to the other or any third party for any Losses arising under and/or in connection with this Agreement (whether in contract, tort (including negligence), breach of statutory duty or otherwise) which are indirect or consequential Losses, or for loss of profit, revenue, savings (including anticipated savings), data (save as set out in clause 24.4(d)), goodwill, reputation (in all cases whether direct or indirect) even if such Losses were foreseeable and notwithstanding that a party had been advised of the possibility that such Losses were in the contemplation of the other party or any third party.

Many IT lawyers in complex IT agreement negotiations press for an express term exempting certain damages from the general “loss of profit” disclaimers. For example, it is not unusual for IT agreements to exclude from the “loss of profits” disclaimer costs of cover and other costs and expenses to procure a replacement system, or costs to acquire or bring a system in house. Some IT agreements also have clauses that expressly require the repayment of fees paid for terminated contracts. The MSA contained no such exceptions from the general loss of profit disclaimer.

The court ruled that the loss of profit disclaimer prevented CISGIL from recovering its damages for the wasted expenses. The court’s reasons for denying these damages went as follows.

At common law, damages for breach of contract are compensatory and are intended to give effect to the contractual bargain. Where a party sustains a loss by reason of a breach of contract, the party is, so far as money can do it, to be placed in the same situation, with respect of damages, as if the contract had been performed.[20]

In a commercial contract, the value of such damages is usually measured by reference to 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 (“the expectation basis”).[21]

A claimant may elect to claim damages on an alternative basis by reference to expenditures incurred in reliance on the defendant’s promise, such as sums paid to the defendant or other wasted costs (“the reliance basis”). This damage methodology is also intended to compensate the innocent party for the loss of the contractual bargain. Where a claim is made for reliance losses, the innocent party is not entitled to recover expenditures that would have been wasted in any event if the bargain would have been loss-making.[22]

The court then purported to apply these principles to the facts of the case and reached the conclusion that the claim for wasted expenditures was really a claim for loss of profits. It was therefore excluded by the liability disclaimer. The court summarized its reasons as follows:

Applying the above principles to this case, the starting point is to identify the contractual benefit lost as a result of IBM’s repudiatory breach of contract.

CISGIL’s business was the underwriting and distribution of general insurance products. The new IT solution which IBM promised to supply was anticipated to improve CISGIL’s competitiveness as a market-leading digital and data-based business, which would produce substantial savings, increased revenues and increased profits.

The loss of the bargain suffered by CISGIL as a result of IBM’s repudiatory breach comprised the savings, revenues and profits that would have been achieved had the IT solution been successfully implemented.

A conventional claim for damages in this type of commercial case would usually be quantified based on those lost savings, revenues and profits. CISGIL is entitled to frame its claim as one for wasted expenditure but that simply represents a different method of quantifying the loss of the bargain; it does not change the characteristics of the losses for which compensation is sought.

Clause 23.3 of the MSA excludes any claim by either party for “loss of profit, revenue, savings (including anticipated savings) … (in all cases whether direct or indirect) …”

In accordance with the above analysis, such a claim is excluded, whether it is quantified as the value of the lost profit, revenue and savings, or as wasted expenditure.

It follows that CISGIL’s claim for wasted expenditure is excluded by clause 23.3.

The court’s decision on this point is open to significant doubt. CISGIL had contracted to acquire a functioning computer platform to run its business. Its goal was to procure a (functioning) capital asset. That was the contractual benefit or bargain IBM promised to deliver. Had the contract been performed CISGIL would have had such an asset. By virtue of IBM’s wrongful termination and repudiation of the contract CISGIL had incurred wasted costs of £128 million. This made its investment in the new computer system asset valueless. Had CISGIL decided to start from scratch after IBM’s repudiation of the agreement it would have had to pay another vendor for the costs of procuring a new system. Assuming IBM had charged CISGIL the market price, CISGIL’s damages would have been £128 million e.g. the costs of the new system, less what it had agreed to pay IBM, plus the wasted amounts incurred that resulted in no value. There is no good reason to asses CISGIL’s position differently merely because it decided not to replace the system. It still ended up with a valueless asset.

The judge’s interpretation of the clause flouted fundamental principles of contractual interpretation. The judge acknowledged that in interpreting contracts courts apply the following principles.

There is no dispute as to the approach by the Court to questions of contractual interpretation. When interpreting a written contract, the Court is concerned to ascertain the intention of the parties by reference to what a reasonable person, having all the background knowledge which would have been available to the parties, would have understood them to be using the language in the contract. It does so by focussing on the meaning of the relevant words in their documentary, factual and commercial context. That meaning has to be assessed in the light of (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the contract, (iii) the overall purpose of the clause and the contract, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party’s intentions: Arnold v Britton [2015] UKSC 36 per Lord Neuberger Paras.15-23; Rainy Sky SA v Kookmin Bank [2011] UKSC 50 per Lord Clarke Paras.21-30; Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38 per Lord Hoffmann Paras.14-15, 20-25.

These principles are consistent with the principles of contractual interpretation applied in Canada, recently summarized by the Supreme Court of Canada in R v Resolute FP Canada Inc.[23] (relying in part on U.K. law):

As we will explain below, contractual interpretation also requires courts to consider the principle of commercial reasonableness and efficacy. Contracts ought therefore to be interpreted “in accordance with sound commercial principles and good business sense” (Scanlon v. Castlepoint Development Corp. (1992), 1992 CanLII 7745 (ON CA), 11 O.R. (3d) 744, at p. 770).  As Lord Diplock explained in Antaios Compania Naviera S.A. v. Salen Rederierna A.B., [1985] 1 A.C. 191 (H.L.), at p. 201, “if detailed semantic and syntactical analysis of a word in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense”.  The principle that requires contracts to be read in a commercially reasonable and efficient manner is therefore an important interpretive aid in construing contractual terms.

Ultimately, contractual interpretation involves the application of various tools — including consideration of the factual matrix and the principle of commercial reasonableness — in order to properly understand the meaning of the words used by the parties to express their agreement.

The task of the judge was to interpret what was intended by the disclaimer for loss of profit in the context of the IT agreement. Yet, the judge did not even embark on this analysis. The judge did not interpret the natural and ordinary meaning of the words in the clause, in any other relevant provisions of the contract, or the overall purpose of the words in the disclaimer. For example,one might well have considered that the phrase “loss of profit” could be given some meaning by its association with the terms revenue and savings.

The judge also diid not assess the meaning of the loss of profit exception having regard to the principles of commercial reasonableness and commercial common sense.[24]

Most business persons would reasonably have expected the clause to exclude an actual loss of profits resulting from a contract breach. For example, if CISGIL had claimed that it was unable to carry on business because the system had not been completed on time, or at all, and it lost revenues or profits as a result, those claims would reasonably have been barred. If the IBM system went down during production and CIS lost sales and resulting profits, a claim for such losses would reasonable also have been expected to be excluded. But, it is highly unlikely, on any objective consideration of what the parties had intended, that the loss of profit disclaimer would have been understood as being intended to exclude recovery of damages for wasted expenses where the hoped for contractual benefit was not at all delivered. If the court’s analysis is correct the loss of profit disclaimer could theoretically apply to prevent recovery of wasted expenses arising from the purchase of virtually any faulty good by a for profit business as any item theoretically is acquired in the pursuit of profit. So construed the disclaimer would have a sweeping unreasonable reach that flouts commonsense and which contracting parties would not intend.[25]

Willful termination

Even had CISGIL been successful on the wasted expense claim, it would have run up against the damages cap which was approximately £83 million (even the experts for the parties couldn’t agree on what the damage cap was). However, CISGIL would have been entitled to a higher limit of liability (or stretch cap) in the event IBM’s breach was a “willful default” within the meaning of the IT agreement.[26]

Many IT agreements negotiated by good information technology lawyers contain a complete exclusion from the limitation of liability, or at least a stretch cap, if the supplier wrongfully terminates or abandons the agreement or refuses to provide contracted for services where not entitled under the agreement. These exclusions are intended to prevent suppliers from abandoning a project because it is cheaper to walk away than it is to complete the work at a loss. My colleagues and I have had many long negotiations over such terms with IT suppliers.

The IT agreement contained a “willful default” exception to the general damages cap. Willful default was worded rather weakly as “an intentional breach of the Agreement with either an intent to cause harm or recklessness with regard to the consequences of the breach.”

CISGIL contended that IBM was in willful default. It claimed that IBM knew at the time that it issued the AG5 invoice that the preceding milestones had not been achieved, it did not have a relevant purchase order and the milestone payment was not due. Further, IBM knew at the time that it purported to exercise termination rights that the AG5 invoice was not due and payable, the AG5 invoice was disputed by CISGIL and CISGIL had asserted rights of set-off in respect of the AG5 invoice. Further as it pleaded in its case against IBM:

IBM’s repudiation was an intentional breach of the MSA, designed to bring the MSA to an end so that IBM could escape its obligations under the MSA, the Implementation SOW and the other SOWs, and it was reckless as to the consequences of such intentional breach. As such, it amounted to willful default.

IBM’s position was that, even if the court found that its purported termination was wrongful, it was not in willful default within the meaning of the MSA, inter alia, because the breach was not done “with either an intent to cause harm or recklessness with regard to the consequences of the breach”.

The court agreed with IBM and summarized its findings on the motives of the parties when it came to the termination.

Mr Perrott was challenged in cross-examination about IBM’s motive for purporting to terminate. He denied that IBM was not prepared to take over the source code from IG; his view was that CISGIL changed its mind and decided that it no longer wanted the new system or to invest in a capital intensive business.

Having read the contemporaneous documents and having listened carefully to the factual witnesses, it is clear that by July 2017 both parties were resigned to abandonment of the project. Both parties retained legal teams and tried to manoeuvre themselves into a position where they could extricate themselves from the MSA with minimum damage. A high-risk strategy was adopted on both sides; the AG5 milestone payment, a modest sum in relation to the high value of the overall project, was the vehicle used to bring the project to an end.

Both parties took a decision not to operate the contractual disputes resolution procedure to resolve the AG5 invoice dispute until July 2017, when there were tentative, belated discussions about mediation. When Mr Perrott called Mr Summerfield to tell him that IBM had decided to terminate, neither party made any attempt to save the project.

None of the above indicates intentional or reckless breach; both parties thought that they were entitled to adopt their chosen stance and that their analysis of the issue was correct, or at least arguable. IBM rightly understood that it was entitled to payment in respect of the AG5 milestone. It wrongly thought that CISGIL was not entitled to reject the invoice and/or failed to do so effectively. It wrongly thought that it was entitled to exercise termination rights under the MSA.

For the above reasons, in my judgment there was no willful default on the part of IBM within the meaning of the MSA.

Conclusions and takeaways

This case shows the devastating impacts of a failed IT procurement transaction. Both parties lost big time. It is debatable as to who won this lawsuit. IBM lost on some important contract issues, especially on the wrongful contract termination issue. However, IBM was the overwhelmingly bigger winner because of the court’s findings on the limitations and disclaimers of liability.

One might well expect that this case is not over. There is too much at stake for there not to be an appeal.

There are lots of lessons from this case for information technology lawyers to consider when negotiating IT agreements such as the following:

  • If the contract gives the customer a right to dispute invoices in good faith, what should the reasonable period for such dispute should be. Seven days is very short.
  • Should payments dependent on milestones also be dependent on the supplier not also being in significant breach of the agreement?
  • Whether the contract should have clear rights to terminate a contract for failure to meet critical milestones.
  • Whether to expressly include or exclude claims for equitable set-off.
  • Whether clauses that are premised on the knowledge of the supplier should be expanded to include knowledge of suppliers and material suppliers.
  • How “willful default” clauses should be worded in exclusions from limits of lability and whether they should include a broad range of situations in which a supplier decides to walk away from a contract because it is cheaper to walk away than to perform its contractual obligations.
  • What damages should excluded from standard consequential/loss of profits disclaimer clauses.

Need an IT lawyer for help with an IT agreement?

If you need the help of information technology lawyers for an IT agreement don’t hesitate to reach out to lawyers at McCarthy Tétrault. McCarthy Tétrault is ranked Band 1 by Chambers Canada in Information Technology and has 3 of the 6 Band 1 ranked lawyers nationwide (Barry Sookman, Christine Ing, and George Takach) with Charles Morgan (ranked in Band 2) (Charles Morgan is also the National Co-leader of McCarthy Tétrault’s industry leading Cyber/Data Group along with Dan Glover). McCarthy Tétrault also has tremendous bench strength and experience in advising on, and litigating, failed IT procurements.

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[1] The notice to IBM stated the following:

“By reason of the substantial loss and damage that CISGIL has clearly incurred, as identified above, CISGIL reserves the right to exercise its right to set off any IBM invoices which properly fall due for payment against its much larger claim for damages arising from IBM’s breaches. It will assess this on a case by case basis as invoices are tendered or are said to fall due for payment Any decision by CISGIL to make payment of a particular invoice, even if disputed and paid under protest, should not be construed as an acceptance that any other invoices tendered are due and payable or waiver of its general set off rights.”

[2] CISGIL pleaded this allegation as follows:

IBM’s repudiation was an intentional breach of the MSA, designed to bring the MSA to an end so that IBM could escape its obligations under the MSA, the Implementation SOW and the other SOWs, and it was reckless as to the consequences of such intentional breach. As such, it amounted to willful default.

[3] The Court quote from The Atlantic Tonjer [2019] EWHC 1213 (Comm) per Sir Ross Cranston as follows:

“[32] Those time periods had been negotiated by two commercial parties. There was no suggestion that they were not of equal bargaining power in the shipping market. Consequently, the hypothetical case of a challenge to an invoice having to be given in 2 or 3 business days has no traction. Even if that had been the case it would have been the period freely negotiated and determined by express agreement. In any event, clause 12(e) does not preclude charterers from bringing claims (in our case the counterclaim referenced by the Tribunal) or withholding payment (that being subject, of course, to notice being given, so that if no notice if given a defence to payment cannot be raised). What clause 12(e) requires is prompt payment or prompt identification of any issue preventing payment.

[33] On this reading of the clause, if charterers reasonably believe that there is an error in the invoice they can withhold payment of the disputed amount by notifying the owners under the clause within the period they have agreed in the contract. They also have the audit rights under clause 12 (g) to reclaim amounts paid through accounting-type errors (wrong hire rate, wrong number of meals and so) up to four years ahead. Further, as the Tribunal correctly concluded, the charterers can always bring a counterclaim if they have paid sums which they later believe were not properly payable. Counterclaims in this context would include a claim for breach of contract or one for unjust enrichment.

[34] In other words, clause 12(e) is not analogous to a time bar clause or any other type of clause limiting or excluding liability. Nothing is being implied into the clause. It may be that the charterers are required by clause 12(e) to act in a certain way if they dispute an invoice and wish to withhold payment. But as Lewison LJ said in the Interactive E-Solutions case [2018] EWCA Civ 62, this type of clause is to be construed in accordance with the same principles as any other clause. Adopting that approach, the clause properly construed means that, within 21 days of receipt of an invoice, charterers have to form a view about it. If they reasonably believe it is incorrect they do not have to pay, but they must give the requisite notice.

[35] This interpretation of clause 12(e) is in line with commercial common sense. In paragraph 46 of its Reasons, the Tribunal quoted the impeccable authority of Robert Goff J in The Kostas Melas [1981] 1 Lloyd’s Rep 18, that cash flow is a matter of considerable, sometimes crucial, importance to the owners of ships. That dictum has been underlined in later cases and is undisturbed by anything said in the judgments in Spar Shipping AS v Grand China Logistics (Group) Co Ltd [2016] EWCA Civ 982[2017] Bus LR 663. In my view there is nothing uncommercial in charterers being obliged to raise bona fide disputes timeously, at a time when the owners have an opportunity to exercise the rights and remedies they have under the charterparty such as under clause 12(f).”

[4] Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.

[5] C.M. Callow Inc. v. Zollinger, 2020 SCC 45.

[6] The judge summarized the law of equitable set-off as follows:

In Geldof Metallconstructie NV v Simon Carves Ltd [2010] EWCA Civ 667 Rix LJ set out a jurisprudential analysis of the law of equitable set-off:

“[22] It is generally considered that the modern law of equitable set-off dates from Hanak v. Green [1958] 2 QB 9. Morris LJ’s judgment there has been described as a masterly account of the subject (Gilbert Ash (Northern) v. Modern Engineering (Bristol) Ltd [1974] AC 689 at 717 per Lord Diplock). In Dole Dried Fruit v. Trustin Kerwood Ltd [1990] 2 Lloyd’s Rep 309 at 310 Lloyd LJ said that for all ordinary purposes, the modern law of equitable set-off is to be taken as accurately stated there. Morris LJ set out the law in these terms:

“The position is, therefore, that since the Judicature Acts there may be (1) a set-off of mutual debts; (2) in certain cases a setting up of matters of complaint which, established, reduce or even extinguish the claim; and (3) reliance as a matter of defence upon matters of equity which formerly might have called for injunction or prohibition…The cases within group (3) are those in which a court of equity would have regarded the cross-claims as entitling the defendant to be protected in one way or another against the plaintiff’s claim” (at 23).

However, that did not mean that all cross-claims may be relied on as defences to claims. In his examination of Bankes v. Jarvis [1903] 1 KB 549, Morris LJ identified two factors as critical: it would have been “manifestly unjust” for the claim to be enforced without regard to the cross-claim; and “there was a close relationship between the dealings and transactions which gave rise to the respective claims” (at 24)…

[26]… Federal Commerce & Navigation Co Ltd v. Molena Alpha Inc [1978] 2 QB 927 (The “Nanfri”) … was the occasion for a further consideration of the doctrine of equitable set-off. Lord Denning MR said (at 974G/975A):”

“… We have no longer to ask ourselves: what would the courts of common law or the courts of equity have done before the Judicature Act? We have to ask ourselves: what should we do now so as to ensure fair dealing between the parties? See United Scientific Holdings Ltd. v. Burnley Borough Council [1978] A.C. 904 per Lord Diplock. This question must be asked in each case as it arises for decision: and then, from case to case, we shall build up a series of precedents to guide those who come after us. But one thing is clear: it is not every cross-claim which can be deducted. It is only cross-claims that arise out of the same transaction or are closely connected with it. And it is only cross-claims which go directly to impeach the plaintiff’s demands, that is, so closely connected with his demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim. Such was…Hanak v. Green...”

In summarising the applicable principles, Rix LJ stated at [43]:

“(ii) There is clearly a formal requirement of close connection. All the modern cases state that, whether Hanak v. GreenThe NanfriThe Dominique (by reference to the Newfoundland Railway case), Dole Dried Fruit or Bim Kemi. The requirement is put in various ways in various cases. Morris LJ in Hanak v. Green spoke of a “close relationship between the dealings and transactions which gave rise to the respective claims”. Lord Denning in The Nanfri spoke of claims and cross-claims which are “closely connected”. How closely? “[S]o closely connected with his demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim”. The Dominique adapted the Newfoundland Railway test and spoke of a cross-claim “flowing out of and inseparably connected with the dealings and transactions which also give rise to the claim”. Dole Dried Fruit returned to Lord Denning’s test in The Nanfri but also spoke of a claim and cross-claim which was so “inseparably connected that the one ought not to be enforced without taking into account the other”. Bim Kemi expressed a preference for the test in The Dominique, while warning against being caught up in the nuances of different formulations…

(iv) There is also clearly a functional requirement whereby it needs to be unjust to enforce the claim without taking into account the cross-claim. This functional requirement is emphasised in all the modern cases, viz Hanak v. GreenThe AriesThe NanfriDole Dried Fruit, Esso v. Milton, and Bim Kemi. The only modern authority cited above which does not in terms refer to the functional requirement of injustice is Lord Brandon’s discussion in The Dominique. This has led Potter LJ in Bim Kemi (at para 38) to remark on the absence of reference to “manifest injustice” by Lord Brandon: but nevertheless it did not lead him to dispense with that requirement (ibid). It seems to me impossible to do so: it is not coherent to have a doctrine of equitable set-off which ignores the need for consideration of aspects of justice and fairness…

(vi) For all these reasons, I would underline Lord Denning’s test, freed of any reference to the concept of impeachment, as the best restatement of the test, and the one most frequently referred to and applied, namely: “cross-claims…so closely connected with [the plaintiff’s] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim”. That emphasises the importance of the two elements identified in Hanak v. Green; it defines the necessity of a close connection by reference to the rationality of justice and the avoidance of injustice; and its general formulation, “without taking into account”, avoids any traps of quasi-statutory language which otherwise might seem to require that the cross-claim must arise out of the same dealings as the claim, as distinct from vice versa…”

In Fearns v. Anglo-Dutch Paint & Chemical Co Ltd [2010] EWHC 2366 (Ch) George Leggatt QC (as he then was) reviewed the authorities on the nature of equitable set-off, including Lord Denning’s formulation in The Nanfri:

“[19] The correct test for equitable set-off has been further considered in later cases, most recently by the Court of Appeal in Geldof Metallconstructie NV v Simon Carves Ltd [2010] EWCA Civ 667. In Geldof, at para 43(vi), the Court of Appeal has endorsed as the best statement of the test, and the one most frequently referred to and applied, that formulated by Lord Denning in Federal Commerce & Navigation Co Ltd v Molena Alpha Inc (The “Nanfri”) [1978] 2 QB 927 at 975, namely that equitable set-off is available where a cross-claim is “so closely connected with [the claim] that it would be manifestly unjust to allow [the claimant] to enforce payment without taking into account the cross-claim”…

[23] The importance of this decision is that it establishes that an equitable set-off can be relied on outside the context of proceedings as an immediate answer to a liability to pay money otherwise due and to the exercise of rights, such as a right to terminate a contract, which are contingent on such non-payment.”

In Equitas Limited and Others v. Walsham Brothers & Co Ltd [2013] EWHC 3264 (Comm); Males J (as he then was) summarised the operation of such equitable set-off at [176]:

“A right of set off may be exercised by being asserted. Upon the exercise of the right in this way, a claimant who seeks to enforce or rely on its own claim (for example, by terminating a contract, as in the typical case of withdrawal from a time charter for non-payment of hire) without taking the cross claim into account acts at its peril. But if the set off is not even asserted, it can have no effect at all. A cross claim which has not even been asserted can hardly affect the claimant’s conscience so as to make it manifestly unjust to enforce the claim without taking account of the cross claim. However, even the exercise of the right in this way does not operate to extinguish or reduce the claim. That can only be done by agreement or by judgment …”

[7] The Court reviewed the law on this issue as follows:

There is established authority that clear words would be required if such rights of set-off were to be excluded. In Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689 Lord Diplock stated at p.717:

“It is, of course, open to parties to a contract for sale of goods or for work and labour or for both to exclude by express agreement a remedy for its breach which would otherwise arise by operation of law … But in construing such a contract one starts with the presumption that neither party intends to abandon any remedies for its breach arising by operation of law, and clear express words must be used in order to rebut this presumption.”

In Nile Co for the Export of Agricultural Crops v. Bennett (H & JM) (Commodities) Ltd [1986] 1 Lloyd’s Rep. 555, the court was required to construe a contract for shipments of potatoes, some of which were found on delivery to be in an unsatisfactory condition. Evans J held that the contract excluded the defendants’ right of deduction but did not bar the claim. Clause 4 of the agreement did not preclude the defendant from bringing damages claims in cases where they had failed to invoke the clause 4 procedure but it did prevent them from deducting such claims from the fob amount drawn by the plaintiffs which was payable in full subject only to claims made in accordance with that clause:

“There is no express wording in cl.4 which purports to have this effect. The question is, therefore, whether the clause properly construed carries by implication the clear and unequivocal meaning for which the plaintiffs contend. In my judgment, two factors in particular work strongly in their favour. First, the defendant can hardly be heard to say that it was theirs and the plaintiffs’ intention, when the agreement was made, that they were to remain free to ignore the cl.4 machinery and to make their damages claims or deductions in such other ways as they might choose, either at the time or subsequently within (presumably) a six-year limitation period. Secondly, if it is accepted that ignoring cl. 4 would itself amount to a breach of contract, for which the defendants would be liable to the plaintiffs in damages, the measure of such damages would be practically impossible to calculate…

Essentially, the question is one of construction, and the answer depends, as always upon the intention of the parties, properly derived from the terms of their agreement and the admissible surrounding circumstances …”

In Stocznia Gdynia SA v. Gearbulk Holdings Ltd [2009] 1 Lloyd’s Rep. 461 (CA), Moore-Bick LJ confirmed:

“The court is unlikely to be satisfied that a party to a contract has abandoned valuable rights arising by operation of law unless the terms of the contract make it sufficiently clear that that was intended. The more valuable the right, the clearer the language will need to be.”

In FG Wilson (Engineering) Ltd v. John Holt & Company (Liverpool) Ltd [2012] 2 Lloyd’s Rep. 479, Popplewell J (as he then was) elaborated on the approach to be taken as follows:

“[83] A right of set-off may be excluded by agreement of the parties. If set-off is to be excluded by contract, clear and unambiguous language is required … But no more than that is required. In particular such a term is not to be treated in the same way as an exclusion clause…

[85] … Whether the set-off would operate as a substantive defence or as a remedy, what matters in each case is whether there has been clearly expressed an intention that the payment is to be made without reference to the claim which would otherwise be set-off. Where the language used does not mention set-off, it may be difficult for a party to satisfy the requirement of clarity if the clause relied on does not in terms qualify the payment obligation. Conversely where the provision does expressly qualify the payment obligation, it may readily be construed as sufficiently clear to be effective (as in Coca-Cola Financial Corp v Finsat Ltd [1998] Q.B. 43; WRM v Wood and Rohlig (UK) Ltd v Rock Unique Ltd [2011] EWCA Civ 18). But there is no principle of construction that a no set-off clause cannot be effective unless it is expressed in terms to qualify the payment obligation.”

[8] The court’s reasons for denying the set off right could be used to avoid paying the invoice are set out below:

There is a distinction to be drawn between a contractual provision that excludes rights of set-off and a contractual provision that makes the exercise of any right of set-off against particular payments conditional on notice. Clear and unambiguous language will be required before the Court is satisfied that a party has given up valuable rights of set-off; such a stringent test may not be required where a party retains its rights of set-off but agrees that notice conditions apply to the exercise of such rights.

In this case, the starting point is that there is no term in Schedule 5 or elsewhere in the MSA which expressly excludes the parties’ rights of set-off.  Therefore, the presumption is that the parties have retained all remedies for breach of contract, including any equitable rights of set-off.

That presumption is reinforced by Clause 42 of the MSA, which provides:

“The rights and remedies of the parties in connection with this Agreement are cumulative and, except as expressly stated in this Agreement, are not exclusive of and may be exercised without prejudice to any other rights or remedies provided in this Agreement by law or equity or otherwise. Except as expressly stated in this Agreement (or in law or in equity in the case of rights and remedies provided by law or equity) any right or remedy may be exercised wholly or partially from time to time.”

However, the language of paragraph 11.7 of Schedule 5 expressly provides that invoices must be paid unless they have been disputed in accordance with the agreed procedure…

Paragraph 11.11 sets out a mandatory period within which an invoice may be disputed…

Paragraph 11.12 imposes restrictions on the right to withhold part or all of any invoiced payment:

“Provided the Customer has given the notice in paragraph 11.11, the Customer may withhold payment of, and meet with the Supplier to discuss, the Disputed Amount …”

The effect of those paragraphs, read together, was clear and unambiguous and introduced a ‘pay now, argue later’ principle. They did not exclude any right of set-off; CISGIL would retain its right of set-off against future payments due and would retain its right to counterclaim for damages; but the paragraph 11 provisions restricted the exercise of such set-off rights against invoices to those in respect of which a valid notice of dispute had been given within seven days…

If CISGIL was unable to rely on set-off so as to render the AG5 invoice a Disputed Amount, IBM was entitled to issue a Final Notice. IBM’s entitlement to terminate was triggered by the failure of CISGIL to pay those undisputed amounts within fifteen days of receipt of the Final Notice.

For the above reasons, if, contrary to the Court’s finding above, CISGIL had failed to dispute invoice AG5 within seven days as required by paragraph 11.11 of Schedule 5, it would have lost its right to rely on any equitable set-off to justify withholding payment in respect of that invoice and to prevent IBM relying on clause 26.7 to exercise its right to terminate.

[9] Clause 26.2 contained CISGIL’s right to terminate for breach:

“The Customer may terminate the Agreement and/or any of the Services in whole or in part immediately, by giving written notice to the Supplier, (as of a date specified in the notice of termination, such date not to be earlier than the date on which the notice is received by the Supplier) if one or more of the following occurs:

(a) the Supplier is in material breach of this Agreement which is incapable of remedy or which, if capable of remedy, has not been remedied within 30 (thirty) days of receipt of a written notice from the Customer specifying the breach and requiring the same to be remedied …”

[10] The “prevention principle” was summarized by the trial judge as follows:

The prevention principle was considered by Jackson J in Multiplex Constructions (UK) Ltd v. Honeywell Control Systems Ltd [2007] EWHC 447 (TCC). Having considered the relevant authorities, he derived the following propositions at [56]:

“(i)         Actions by the employer which are perfectly legitimate under a construction contract may still be characterised as prevention, if those actions cause delay beyond the contractual completion date.

(ii)         Acts of prevention by an employer do not set time at large, if the contract provides for extension of time in respect of those events.

(iii)        In so far as the extension of time clause is ambiguous, it should be construed in favour of the contractor.”

[11] The judge relied on a prior case that set out the law on this issue quotoing from Adyard Abu Dhabi v. SD Marine Services [2011] EWHC 848 (Comm) per Hamblen J (as he then was):

“[252] Even if Adyard is entitled to rely on the prevention principle this could only avail it, if its causation case is sound in law…

[263] In my judgement Adyard’s approach is wrong as a matter of both principle and authority. It is also contrary to common sense …

[264] It is wrong in principle because in essence Adyard’s case is that there is no need to prove causation in fact. On its case there is no need to prove the event or act causes any actual delay to the progress of the works. Notional or theoretical delay suffices. That would seem to involve turning the prevention principle on its head. The rationale of the principle is that it is unfair for a party to insist on performance of an obligation which he has prevented the other party from performing. That necessarily means prevention in fact; not prevention on some notional or hypothetical basis.

[281] A … requirement of proof of delay to the actual progress of the works is apparent in the prevention principle cases, albeit that there the issue is viewed retrospectively.

[282] The conduct therefore has to render it “impossible or impractical;

icable for the other party to do the work within the stipulated time”. The act relied on must actually prevent the contractor from carrying out the works within the contract or, in other words, must cause some actual delay.

[12] The court summarized the principles are follows:

The general presumption is that no additional terms should be implied into a contract. As Lord Hoffmann observed in Attorney General of Belize v. Belize Telecom Ltd [2009] 1 WLR 1988 at [17]:

“The question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs. The most usual inference in such a case is that nothing is to happen. If the parties had intended something to happen, the instrument would have said so. Otherwise, the express provisions of the instrument are to continue to operate undisturbed. If the event has caused loss to one or other of the parties, the loss lies where it falls.”

In Marks & Spencer plc v. BNP Paribas Securities Services Trust [2015] UKSC 72, the Supreme Court set out the requirements for implying a term into a commercial contract, approving the test set out in the Privy Council case BP Refinery (Westernport) Pty Ltd v. Shire of Hastings [1978] 52 ALJR 20 by Lord Simon of Glaisdale that:

“for a term to be implied, the following conditions (which may overlap) must be satisfied: (1)  it must be reasonable and equitable; (2)  it must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it; (3)  it must be so obvious that ‘it goes without saying’;  (4)  it must be capable of clear expression; (5)  it must not contradict any express term of the contract.”

Having approved the above summary, Lord Neuberger added six comments at [21]:

“First, In Equitable Life Assurance Society v Hyman  [2002] 1 AC 408, 459 Lord Steyn rightly observed that the implication of a term was ‘not critically dependent on proof of an actual intention of the parties’ when negotiating the contract. If one approaches the question by reference to what the parties would have agreed, one is not strictly concerned with the hypothetical answer of the actual parties, but with that of notional reasonable people in the position of the parties at the time at which they were contracting. Secondly, a term should not be implied into a detailed commercial contract merely because it appears fair or merely because one considers that the parties would have agreed it had it been suggested to them. Those are necessary but not sufficient grounds for including a term. However, and thirdly, it is questionable whether Lord Simon’s first requirement, reasonableness and equitableness, will usually, if ever, add anything: if a term satisfies the other requirements, it is hard to think that it would not be reasonable and equitable. Fourthly, … although Lord Simon’s requirements are otherwise cumulative, I would accept that business necessity and obviousness, his second and third requirements, can be alternatives in the sense that only one of them needs to be satisfied, although I suspect that in practice it would be a rare case where only one of those two requirements would be satisfied. Fifthly, if one approaches the issue by reference to the officious bystander, it is ‘vital to formulate the question to be posed by [him] with the utmost care… Sixthly, necessity for business efficacy involves a value judgment… the test is not one of ‘absolute necessity’, not least because the necessity is judged by reference to business efficacy. It may well be that a more helpful way of putting Lord Simon’s second requirement is … that a term can only be implied if, without the term, the contract would lack commercial or practical coherence.”

[13] The reporting obligations in the MSA read as follows:

Clause 4.5(h) of the MSA including the following obligation on the part of IBM:

“The Supplier shall…

(h)         notify the Customer when it becomes aware of any development which may have a material impact on the Supplier’s ability to provide the Services effectively and in accordance with clause 4.5(d) and 4.5(e).”

Appendix A to Schedule 3 provided at paragraph 1.3:

“The Supplier shall report on progress of the Implementation Services, in accordance with schedule 12 (Governance and Reporting).”

Schedule 12 of the MSA included the following material provisions:

“3.1       This Schedule sets out the governance principles, structures, procedures and reporting activities that shall support the parties including, amongst other things, the following:

3.1.2      the ongoing assessment of whether or not Milestone Dates or Key Milestone Dates shall be achieved, and if not, why not and what remedial action can be taken to minimise the adverse impact of any delay;

3.1.3      the early identification of problems and issues so that they may be resolved in a prompt and co-operative manner…

3.2         The parties shall ensure that, through their participation in the Governance Bodies they shall…

3.2.4      engender a relationship that is characterised by trust and openness.”

[14] The subcontract clause read as follows:

Clause 18.5 provided in relation to sub-contracts the following:

“Where the Supplier subcontracts any of its obligations under this Agreement (including those under clauses 18.2 and 18.3):

(a)          the Supplier shall not be relieved of any of its liabilities or obligations under this Agreement by entering into any subcontract and the Supplier accepts liability for the acts and omissions of any Contractor or any of the Contractor’s staff …”

[15] See, Business Development Bank of Canada v Experian Canada Inc., 2017 ONSC 1851.

[16] The clause read as follows:

“The Supplier acknowledges and confirms that it:

(a)          has had the opportunity to carry out:

(i)      a thorough due diligence exercise in relation to the Core Services that are categorised as fixed price in schedule 5 (Charges); and

(ii)     sufficient due diligence in relation to the Core Services that are categorised as capped price in the aggregate in schedule 5 (Charges);

(b)         has raised all relevant due diligence questions about the Core Services which are categorised as fixed price and capped price in schedule 5 (Charges) with the Customer before the Contract Date;

(c)          has received all information from the Customer that has been requested by it pursuant to clause 4.1(b) above, in order to enable it to determine whether it is able to provide the Core Services which are categorised as fixed price and capped price in schedule 5 (Charges) in accordance with the terms of this Agreement and to agree any fixed and capped Charges, and it agrees that no further amounts whatsoever will be sought from the Customer in addition to any such fixed or capped Charges except pursuant to schedule 5 (Charges) and clauses 2.10 and 9.7; and

(d)         has entered into this Agreement in reliance on its own due diligence alone.”

[17] The court’s reasons on the interpretation of the “all reasonable steps” language is set out below:

CISGIL submits that the requirement to take all reasonable steps is a stringent one; there is no discernible difference between an obligation to use all reasonable endeavours and an obligation to use best endeavours. In each case, the obligation is to go on using endeavours until the point is reached when all reasonable endeavours have been exhausted. Reliance is placed on the decision of the Singapore Court of Appeal in KS Energy Services Ltd v BR Energy (M) Sdn Bhd [2014] SGCA 16.

Although the KS Energy judgment contains a very useful review of the authorities on this issue, I do not accept that an obligation to use ‘all reasonable endeavours’ is necessarily the same as an obligation to use ‘best endeavours’, although in many cases there may be no discernible difference in practice.

In Rhodia International Holdings Ltd & Anor v Huntsman International LLC [2007] EWHC 292 Julian Flaux QC (as he then was), sitting as a deputy High Court Judge, considered this issue:

“[31] First, there was some debate at the hearing as to whether “reasonable endeavours” is to be equated with “best endeavours”, a question on which there seems to be some division of judicial opinion. At the end of the day I am not convinced that it makes much difference on the facts of this case, but since the point was fully argued, I should deal with it. Mr Beazley QC for Rhodia contended that there was no difference between the two phrases. He relied upon a passage from the judgment of Buckley LJ in IBM v Rockware Glass [1980] FSR 335 at 339:

“in the absence of any context indicating the contrary, this [an obligation to use its best endeavours] should be understood to mean that the purchaser is to do all he reasonably can to ensure that the planning permission is granted”.

There are similar statements in the judgments of Geoffrey Lane LJ at 344-5 and Goff LJ at 348.

[32] Mr Beazley also relied upon what Mustill J said in Overseas Buyers v Granadex [1980] 2 Lloyd’s Rep 608 at 613:”

“it was argued that the arbitrators can be seen to have misdirected themselves as to the law to be applied, for they have found that EIC did “all that could reasonably be expected of them”, rather than finding whether EIC used their “best endeavours” to obtain permission to export, which is the test laid down by the decided cases. I can frankly see no substance at all in this argument. Perhaps the words “best endeavours” in a statute or contract mean something different from doing all that can reasonably be expected-although I cannot think what the difference might be. (The unreported decision of the Court of Appeal in IBM v Rockware Glass upon which the buyers relied, does not to my mind suggest that such a difference exists…).

Mr Beazley pointed out that in Marc Rich v SOCAP (1992) Saville J equated best endeavours with due diligence and that Rix LJ in Galaxy Energy v Bayoil [2001] 1 Lloyd’s Rep 512 at 516 equated reasonable efforts with due diligence, which suggested that best endeavours and reasonable endeavours meant the same thing. He sought to distinguish the unreported decision of Rougier J in UBH (Mechanical Services) v Standard Life (1986) that an obligation to use reasonable endeavours was less stringent than an obligation to use best endeavours, on the grounds that the point was not argued but conceded by Counsel.

[33] I am not convinced that (apart from that decision of Rougier J [in UBH]) any of the judges in the cases upon which Mr Beazley relied were directing their minds specifically to the issue whether ‘best endeavours’ and ‘reasonable endeavours’ mean the same thing. As a matter of language and business common sense, untrammelled by authority, one would surely conclude that they did not. This is because there may be a number of reasonable courses which could be taken in a given situation to achieve a particular aim. An obligation to use reasonable endeavours to achieve the aim probably only requires a party to take one reasonable course, not all of them, whereas an obligation to use best endeavours probably requires a party to take all the reasonable courses he can. In that context, it may well be that an obligation to use all reasonable endeavours equates with using best endeavours and it seems to me that is essentially what Mustill J is saying in the Overseas Buyers case. One has a similar sense from a later passage at the end of the judgment of Buckley LJ in IBM v Rockware Glass at 343, to which Mr Edwards-Stuart QC drew my attention.”

What amounts to ‘best endeavours’ was considered by Moore-Bick LJ in Jet2.com v Blackpoool Airport Ltd [2012] EWCA Civ 417:

“[31] In my view the obligation to use best endeavours to promote Jet2’s business obliged BAL to do all that it reasonably could to enable that business to succeed and grow and I do not think the object of the best endeavours is too uncertain to be capable of giving rise to a legally binding obligation …

[32] It was a central plank of BAL’s argument before the judge that the obligation to use best endeavours did not require it to act contrary to its own commercial interests, which, in the context of this case, amounts to saying that BAL was not obliged to accept aircraft movements outside normal hours if that would cause it financial loss. Some support for that conclusion can be found in the cases, … but I think the judge was right in saying that whether, and if so to what extent, a person who has undertaken to use his best endeavours can have regard to his own financial interests will depend very much on the nature and terms of the contract in question …”

Although an obligation to use best endeavours is likely to encompass all reasonable steps that could be taken, it might extend to more than an accumulation of moderate or sensible steps. It is conceivable that the circumstances of a particular case could require the party with such an obligation to go further, such as taking steps that were against his own financial interests, or steps that required extraordinary efforts. Such steps are unlikely to fall within the scope of a ‘reasonable endeavours’ obligation.

The above authorities provide helpful guidance as to meaning of the phrase “all reasonable steps” but that does not obviate the need to interpret those words as part of the agreement between the parties in this case. The scope of “all reasonable steps” must be considered in the context of this particular contract, against the factual matrix and taking into account the expert evidence as to the reasonable steps that could, and should, have been taken.

[18] The court summarized its reasons stating: “Drawing together the above evidence, it is apparent that the parties engaged in very substantial due diligence and fit-gap exercises that enabled IBM to satisfy itself as to IG’s capabilities to meet CISGIL’s requirements. Pre-contract, there was a very long period of collaborative working to ensure that the parties understood what was required and what would be supplied. The results of that collaborative working were the agreed fit-gap schedules. IBM obtained estimates for the time and effort required by IG to carry out the necessary base code development and to meet the requirements in the fit-gap assessments. It interrogated IG’s estimates for resourcing the project and considered the technical and financial risks associated with the same. No fatal flaw was identified in IG’s proposals for organising its work or its methodology. IBM took all reasonable steps to satisfy itself as to the risks, contingencies and circumstances concerned with its performance of the MSA.”

[19] The recoverable damages were calculated as follows:

 

Claim Amount (£)
Programme costs (NOM) 9,652,403
Property Costs (Arndale House) 1,131,589
Testing (including SQS Group Ltd) 1,388,460
Data Migration (Sopra Steria Ltd) 1,018,512
Architects (Sopra Steria Ltd) 365,955
Accenture (UK) Ltd 813,600
Assurance – PWC and PA 305,345
Dual Run Resource 656,787
Management Expenses 146,644
Secondees (CISGIL permanent resource) 408,695
Total 15,887,990

 

[20] The court relied on the following authorities for these propositions:

A fundamental principle of the common law relating to damages for breach of contract is that they are compensatory, intended to give effect to the contractual bargain. The established rule was set out in Robinson v Harman (1848) 1 Exch. 850 per Parke B p.855:

“The rule of the common law is, that where a party sustains a loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation, with respect of damages, as if the contract had been performed.”

The quantum of damages for breach of contract should reflect the value of the contractual bargain of which the claimant has been deprived as a result of the defendant’s breach: The Golden Strait Corporation v Nippon Yusen Kubishika Kaisha [2007] UKHL 12 (HL) per Lord Scott:

“[32] … The underlying principle is that the victim of a breach of contract is entitled to damages representing the value of the contractual benefit to which he was entitled but of which he has been deprived. He is entitled to be put in the same position, so far as money can do it, as if the contract had been performed.

[36] … The lodestar is that the damages should represent the value of the contractual benefits of which the claimant had been deprived by the breach of contract, no less but also no more. ”

The above rules were re-affirmed in Morris-Garner v One Step (Support) Ltd [2018] UKSC 20 per Lord Reed, who stated at [36]:

“The objective of compensating the claimant for the loss sustained as a result of non-performance (an expression used here in a broad sense, so as to encompass delayed performance and defective performance) makes it necessary to quantify the loss which he sustained as accurately as the circumstances permit. What is crucial is first to identify the loss: the difference between the claimant’s actual situation and the situation in which he would have been if the primary contractual obligation had been performed. Once the loss has been identified, the court then has to quantify it in monetary terms.

[21] The court relied on the following passage from Omak Maritime Ltd v Mamola Challenger Shipping Co [2010] EWHC 2026:

“[15] In a typical claim for damages for breach of contract on the expectancy basis both expected profits and necessary expenses will be taken into account. The claimant will claim a sum equal to the benefit he expected to earn from performance of the contract less the costs he would have had to have incurred in order to earn that benefit, which costs would include not only any sum he would have had to pay to the party in breach but also any expenses he would have had to incur in preparation for performance of the contract. Damages calculated in that way would put the claimant in the position he would have been in had the contract being performed.

[22] The court explained the “reliance” basis for assessing damages as follows:

A claimant may elect to claim damages on an alternative basis by reference to expenditure incurred in reliance on the defendant’s promise, such as sums paid to the defendant or other wasted costs (“the reliance basis”): Cullinane v British Rema [1954] 1 QB 292; Anglia Television v Reed [1972] 1 QB 60 per Lord Denning at p.64:

“It seems to me that a plaintiff in such a case as this has an election: he can either claim for loss of profits; or for his wasted expenditure. But he must elect between them. He cannot claim both. If he has not suffered any loss of profits – or if he cannot prove what his profits would have been – he can claim in the alternative the expenditure which has been thrown away, that is, wasted, by reason of the breach.”

Where a claim is made for reliance losses, the innocent party is not entitled to recover expenditure that would have been wasted in any event because the bargain would have been loss-making: C&P Haulage v Middleton [1983] 1 WLR 1461 (CA) per Ackner LJ at pp.1466-1467:

“[The defendant] is not claiming for the loss of his bargain, which would involve being put in the position that he would have been in if the contract had been performed. He is not asking to be put in that position. He is asking to be put in the position he would have been in if the contract had never been made at all. If the contract had never been made at all, then he would not have incurred these expenses, and that is the essential approach he adopts in mounting this claim; because if the right approach is that he should be put in the position in which he would have been had the contract being performed, then it follows that he suffered no damage…

It is not the function of the courts where there is a breach of contract knowingly, as this would be the case, to put a plaintiff in a better financial position than if the contract had been properly performed.”

In CCC Films (London) Ltd v Impact Quadrant Films Ltd [1985] 1 QB 16 (QBD) the court considered the burden of proving that a claimant had suffered no damage in claims for wasted expenditure because of a bad bargain and concluded that the burden of proof was on the defendant: per Hutchinson J at pp.33-39:

“It is … common ground that a claim for wasted expenditure cannot succeed in a case where, even had the contract not being broken by the defendant, the returns earned by the plaintiff’s exploitation of the chattel or the rights the subject matter of the contract would not have been sufficient to recoup that expenditure …

On this crucial question of where the onus of proof lies in relation to whether or not the exploitation of the subject matter of the contract would or would not have recouped the expenditure, there are, however, a number of cases which are more directly relevant …

Even without the assistance of such authorities, I should have held on principle that the onus was on the defendant. it seems to me that at least in these cases were the plaintiff’s decision to base his claim on abortive expenditure was dictated by the practical impossibility of proving loss of profit rather than by unfettered choice, any other rule would largely, if not entirely, defeat the object of allowing this alternative method of formulating the claim. This is because, notwithstanding the distinction to which I have drawn attention between proving a loss of net profit and proving in general terms the probability of sufficient returns to cover expenditure, in the majority of contested cases impossibility of proof of the first would probably involve like impossibility in the case of the second. It appears to me to be eminently fair that in such cases where the plaintiff has by the defendant’s breach being prevented from exploiting the chattel or the right contracted for and therefore, putting to the test the question of whether he would have recouped his expenditure, the general rule as to the onus of proof of damage should be modified in this manner. ”

A claim for reliance losses uses a different method of measurement from that used to calculate expectation losses but both provide compensation for the same loss of the contractual bargain in accordance with the Robinson v Harman principle: Omak Maritime Ltd v Mamola Challenger Shipping Co [2010] EWHC 2026 per Teare J:

“[42] I consider that the weight of authority strongly suggests that reliance losses are a species of expectation losses and that they are neither … “fundamentally different” nor awarded on a different “juridical basis of claim”. That they are a species of expectation losses is supported by the decision of the Court of Appeal in C&P Haulage v Middleton and by very persuasive authorities in the United States, Canada and Australia…

[44] It seems to me that the expectation loss analysis does provide a rational and sensible explanation for the award of damages in wasted expenditure cases. The expenditure which is sought to be recovered is incurred in expectation that the contract will be performed. It therefore appears to me to be rational to have regard to the position that the claimant would have been in had the contract been performed…

[55] I am not therefore persuaded that the right to choose or elect between claiming damages on an expectancy basis or on a reliance basis indicates that there are two different principles at work … I am unable to accept that there are two principles, rather than one, governing the law of damages for breach of contract.

[59] … the weight of authority firmly suggests that an award of reliance damages is governed by the principle in Robinson v Harman …”

In Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QBD) per Leggatt J (as he then was) considered this issue:

“[186] The basis on which wasted expenditure can be recovered as damages for breach of contract was considered by Teare J in Omak Maritime Ltd v Mamola Challenger Shipping Co [2011] 1 Lloyd’s Rep 47. In his masterly judgment Teare J has shown that awarding compensation for wasted expenditure is not an exception to the fundamental principle stated by Baron Parke in Robinson v Harman (1848) 1 Exch 850 at page 855 that the aim of an award of damages for breach of contract is to put the injured party, so far as money can do it, in the same position as if the contract had been performed, but is a method of giving effect to that fundamental principle. That conclusion must logically follow once it is recognised, as it was by the Court of Appeal in C & P Haulage v Middleton [1983] 1 WLR 1461, that the court will not on a claim for reimbursement of losses incurred in reliance on the contract knowingly put the claimant in a better position than if the contract had been performed…

[190] … Parties in normal circumstances contract and incur expenditure in pursuance of their contract in the expectation of making a profit. Where money has been spent in that expectation but the defendant’s breach of contract has prevented that expectation from being put to the test, it is fair to assume that the claimant would at least have recouped its expenditure had the contract been performed unless and to the extent that the defendant can prove otherwise.”

In The Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Ltd [2017] EWHC 2197 (TCC) this Court endeavoured to summarise the above principles at paragraphs [53] to [58], concluding that a claim for wasted costs can be explained as compensation for the loss of the bargain based on a rebuttable presumption that the value of the contractual benefit must be at least equal to the amount that the claimant is prepared to expend in order to obtain such benefit.

[23] 2019 SCC 60

[24] In rendering its decision on whether wasted expenses could be recovered the court also relied on the prior decision in The Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Ltd [2017] EWHC 2197 (TCC). In this case the court rejected an argument that wasted expenses in a failed software procurement could not be recovered because of a loss of profits disclaimer.  The plaintiff’s claim in that case was that it contracted for a functional EMR system. In reliance on the contract, it incurred expenditures that were wasted because of ATOS’ breaches of contract. The court held that the claim was not barred by the disclaimer. According to the court in that case:

However, that does not preclude the Trust from recovering damages to compensate for the loss of a functioning EMR system. That was a contractual benefit to which the Trust was entitled and of which it has been deprived by ATOS’s alleged breach. The rebuttable presumption that the value of that loss is at least equal to the Trust’s expenditure does not transform the claim for loss of the EMR system into a claim for loss of any additional benefits that would flow from use of the EMR system.

ATOS’s submissions wrongly assume that any “contractual benefit” which is presumed to at least equal the value of the expenditure must represent profits, revenues or savings. In most commercial cases, there would be such a defined financial benefit that would be expected to defray the costs incurred and render the bargain financially viable. However, that is not the case where the contractual benefit is non-pecuniary. In those cases, the anticipated benefit is not a financial gain that could defray the costs incurred but rather a non-pecuniary benefit for which the claimant is prepared to incur such costs. In cases where a party does not expect to make a financial gain, it is the non-pecuniary “benefit” that is assigned a notional value equivalent to at least the amount of expenditure.

In this case, regardless whether the EMR system was anticipated to produce any profits, revenue or savings, the Trust would have the use of the EMR system as a contractual benefit. The claim for wasted expenditure is based on a rebuttable presumption, not that the EMR system would produce revenues to defray such expenditure, but rather that the use of the EMR system was worth at least the expenditure incurred. (Emphasis added)

[25] In rendering its decision on whether wasted expenses could be recovered the court also relied on the prior decision in The Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Ltd [2017] EWHC 2197 (TCC). In this case the court rejected an argument that wasted expenses in a failed software procurement could not be recovered because of a loss of profits disclaimer.  The plaintiff’s claim in that case was that it contracted for a functional EMR system. In reliance on the contract, it incurred expenditures that were wasted because of ATOS’ breaches of contract. The court held that the claim was not barred by the disclaimer. According to the court in that case:

However, that does not preclude the Trust from recovering damages to compensate for the loss of a functioning EMR system. That was a contractual benefit to which the Trust was entitled and of which it has been deprived by ATOS’s alleged breach. The rebuttable presumption that the value of that loss is at least equal to the Trust’s expenditure does not transform the claim for loss of the EMR system into a claim for loss of any additional benefits that would flow from use of the EMR system.

ATOS’s submissions wrongly assume that any “contractual benefit” which is presumed to at least equal the value of the expenditure must represent profits, revenues or savings. In most commercial cases, there would be such a defined financial benefit that would be expected to defray the costs incurred and render the bargain financially viable. However, that is not the case where the contractual benefit is non-pecuniary. In those cases, the anticipated benefit is not a financial gain that could defray the costs incurred but rather a non-pecuniary benefit for which the claimant is prepared to incur such costs. In cases where a party does not expect to make a financial gain, it is the non-pecuniary “benefit” that is assigned a notional value equivalent to at least the amount of expenditure.

In this case, regardless whether the EMR system was anticipated to produce any profits, revenue or savings, the Trust would have the use of the EMR system as a contractual benefit. The claim for wasted expenditure is based on a rebuttable presumption, not that the EMR system would produce revenues to defray such expenditure, but rather that the use of the EMR system was worth at least the expenditure incurred. (Emphasis added)

[26] The liability cap was worded as follows:

Clause 23.5 provides:

“Subject to clauses 23.2, 23.3 and 23.6 the Supplier’s aggregate liability to the Customer Group:

(a)          for the Implementation Services, shall be limited to 150% (one hundred and fifty percent) of the Charges paid and/or would have been payable by the Customer if the Implementation Services had been performed in full and there had been no claims or deductions…

 

(e)          arising otherwise under and/or in connection with this Agreement shall be limited to the greater of:

(i)      £15.7 million (fifteen million seven hundred thousand pounds); or

(ii)     125% (one hundred and twenty-five percent) of the total Charges paid and/or would have been payable for the Managed Services in the 12 (twelve) month period immediately preceding the first cause of action arising…

The provisions of this clause 23.5 shall operate as separate and additional liability limitations to all other limitations of liability in this clause 23.5 and clause 23 and any liability for any matters listed in this clause 23.5 shall not form part of any calculation of whether the limits of liability under any other provision of this clause 23 have been reached.”

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