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A reasonable agreement?
August 1994
Computer Audit Update
Limitation of liability
A REASONABLE AGREEMENT?
The Salvage Association's project had involved two contracts.
Diane Horan Disputes between software suppliers and their customers rarely reach the courts - perhaps as a result of effective dispute resolution, fear of the unknown or an aversion to publicity. C o n t r a c t s are agreed and s y s t e m s are implemented on terms which have been developed through a combination of general contractual principles and the experience of those within the industry itself. The decision of Salvage Association v CAP Financial Service Limited (unreported) in the Official Referees Court may signal a stampede to the doors of the court by parties locked in dispute over contracts. Although the case may, in future, be limited to its own facts, at present it is almost unique as a software contract dispute which has been scrutinized by the court. Heard in October 1992, the judgment has only recently been reported and its effects are beginning to reverberate around the IT world. The case provides useful guidelines for all those involved in software contracts, whether at the negotiating stage or in the throes of litigation.
The facts The case concerned a system to be developed by CAP for the Salvage Association's accounting requirements. After analysing the Salvage Association's business, CAP produced a specification which set out system and functional requirements, recommending that these be fulfilled by adapting existing software. The parties agreed to implement the system specification at a cost of a little under £300 000. However, almost a year later the system had not completed acceptance testing. The Salvage Association abandoned the project and sued CAP.
@1994 Elsevier Science Ltd
(1) To produce a system specification: this contract was on CAP's standard terms and conditions. (2) To implement the specification: this contract was n e g o t i a t e d with p r o f e s s i o n a l assistance. The court looked closely at CAP's attempts to limit its liability, narrowly interpreting the relevant clauses. In particular, the negotiated contract contained a limited warranty to "repair and replace". This warranty was linked to CAP's limitation of liability clause which put a ceiling on CAP's liability at £25 000 or the contract price, whichever was the lesser sum. However, the judge held that the warranty would not apply until the system had been accepted. As the limitation of liability clause was tied in with the warranty, this clause would not apply either. The judge also found that the exclusion of the implied terms of merchantability and fitness for the purpose could not be extended to exclude liability for failure to use reasonable care and skill in implementing the contract. If such an implied term were to be excluded it must be specifically stated in the contract.
Reasonableness Certain exclusion and limitation terms must undergo a test of reasonableness before a court will uphold them. The Unfair Contract Terms Act 1977 sets out a number of factors that must be taken into a c c o u n t when d e t e r m i n i n g reasonableness. Crucially for CAP, the Unfair Contract Terms Act 1977 also requires the court to look at: •
The ability of the parties to bear any loss
•
The availability of insurance where a term limits liability to a specified sum of money
11
ComputerAudit Update
Probably the most crushing piece of evidence against CAP concerned its indemnity i n s u r a n c e which had an overall limit of £5 000 000. CAP's management had decided to increase the limit of its liability in its contracts generally to £1 000 000. However, this was not implemented in the contract with the Salvage Association. The limit remained at £25 000. Not surprisingly, the judge found that £25 000 was not a reasonable figure. He also took into account the fact that CAP was able to insure against the failure of the project, whereas the Salvage Association had been unable to obtain appropriate insurance cover.
Implementation The contract did not provide a timetable for the development and testing of the system. Indeed, timetables seem to have been agreed at project meetings throughout the term of the contract, but not adhered to. To the dismay of many in the industry, the judge implied a term that time was of the essence in completing the contract. This conflicts with the position concerning the supply of other goods and services and may not be followed in the future. However, the decision does signal a need for timetabling to be carefully considered.
Damages The Salvage Association claimed damages for a whole series of losses ranging from sums paid under the contracts, through wasted management time to the distant realms of loss of anticipated savings and interest. The judge awarded the Salvage Association damages for direct loss: •
sums paid under both contracts
•
items of wasted expenditure
•
wasted management time
With regard to the Salvage Association's claims for loss of anticipated savings, loss of
12
August 1994
interest and interest charges on payments to third parties, the judge found that these indirect and consequential losses were not proved to his satisfaction or were too remote. Of the £800 000 claimed by the Salvage Association in damages, the court awarded £662 926. Whilst the argument over whether software is 'goods' or 'services' will remain firmly in the realms of academia, the case does clarify the interpretation of certain terms in software contracts. The terms as to merchantability and fitness for purpose of the software, together with the duty to use reasonable care and skill, will be implied into a contract unless specifically excluded. The case also highlights the following: A term excluding or limiting liability for loss or damage arising from negligence (except death or personal injury) must be reasonable. A term excluding or limiting liability for loss or damage arising from breach of contract in standard contract terms must be reasonable. Where liability is restricted to a specified sum of money, the party must be able to show that this sum has been determined by considering insurance, the contract price and potential loss.
NOTEBOOK: A pragmatic solution to Configuration Management Tony Stock Configuration Management is a technique usually associated with large scale software and systems development, but is an essential discipline for anyone who is constructing even the simplest piece of operational software. The solution to the problem on major projects may
©1994 Elsevier Science Ltd
Computer Audit Update
Limitation of liability
A REASONABLE AGREEMENT?
The Salvage Association's project had involved two contracts.
Diane Horan Disputes between software suppliers and their customers rarely reach the courts - perhaps as a result of effective dispute resolution, fear of the unknown or an aversion to publicity. C o n t r a c t s are agreed and s y s t e m s are implemented on terms which have been developed through a combination of general contractual principles and the experience of those within the industry itself. The decision of Salvage Association v CAP Financial Service Limited (unreported) in the Official Referees Court may signal a stampede to the doors of the court by parties locked in dispute over contracts. Although the case may, in future, be limited to its own facts, at present it is almost unique as a software contract dispute which has been scrutinized by the court. Heard in October 1992, the judgment has only recently been reported and its effects are beginning to reverberate around the IT world. The case provides useful guidelines for all those involved in software contracts, whether at the negotiating stage or in the throes of litigation.
The facts The case concerned a system to be developed by CAP for the Salvage Association's accounting requirements. After analysing the Salvage Association's business, CAP produced a specification which set out system and functional requirements, recommending that these be fulfilled by adapting existing software. The parties agreed to implement the system specification at a cost of a little under £300 000. However, almost a year later the system had not completed acceptance testing. The Salvage Association abandoned the project and sued CAP.
@1994 Elsevier Science Ltd
(1) To produce a system specification: this contract was on CAP's standard terms and conditions. (2) To implement the specification: this contract was n e g o t i a t e d with p r o f e s s i o n a l assistance. The court looked closely at CAP's attempts to limit its liability, narrowly interpreting the relevant clauses. In particular, the negotiated contract contained a limited warranty to "repair and replace". This warranty was linked to CAP's limitation of liability clause which put a ceiling on CAP's liability at £25 000 or the contract price, whichever was the lesser sum. However, the judge held that the warranty would not apply until the system had been accepted. As the limitation of liability clause was tied in with the warranty, this clause would not apply either. The judge also found that the exclusion of the implied terms of merchantability and fitness for the purpose could not be extended to exclude liability for failure to use reasonable care and skill in implementing the contract. If such an implied term were to be excluded it must be specifically stated in the contract.
Reasonableness Certain exclusion and limitation terms must undergo a test of reasonableness before a court will uphold them. The Unfair Contract Terms Act 1977 sets out a number of factors that must be taken into a c c o u n t when d e t e r m i n i n g reasonableness. Crucially for CAP, the Unfair Contract Terms Act 1977 also requires the court to look at: •
The ability of the parties to bear any loss
•
The availability of insurance where a term limits liability to a specified sum of money
11
ComputerAudit Update
Probably the most crushing piece of evidence against CAP concerned its indemnity i n s u r a n c e which had an overall limit of £5 000 000. CAP's management had decided to increase the limit of its liability in its contracts generally to £1 000 000. However, this was not implemented in the contract with the Salvage Association. The limit remained at £25 000. Not surprisingly, the judge found that £25 000 was not a reasonable figure. He also took into account the fact that CAP was able to insure against the failure of the project, whereas the Salvage Association had been unable to obtain appropriate insurance cover.
Implementation The contract did not provide a timetable for the development and testing of the system. Indeed, timetables seem to have been agreed at project meetings throughout the term of the contract, but not adhered to. To the dismay of many in the industry, the judge implied a term that time was of the essence in completing the contract. This conflicts with the position concerning the supply of other goods and services and may not be followed in the future. However, the decision does signal a need for timetabling to be carefully considered.
Damages The Salvage Association claimed damages for a whole series of losses ranging from sums paid under the contracts, through wasted management time to the distant realms of loss of anticipated savings and interest. The judge awarded the Salvage Association damages for direct loss: •
sums paid under both contracts
•
items of wasted expenditure
•
wasted management time
With regard to the Salvage Association's claims for loss of anticipated savings, loss of
12
August 1994
interest and interest charges on payments to third parties, the judge found that these indirect and consequential losses were not proved to his satisfaction or were too remote. Of the £800 000 claimed by the Salvage Association in damages, the court awarded £662 926. Whilst the argument over whether software is 'goods' or 'services' will remain firmly in the realms of academia, the case does clarify the interpretation of certain terms in software contracts. The terms as to merchantability and fitness for purpose of the software, together with the duty to use reasonable care and skill, will be implied into a contract unless specifically excluded. The case also highlights the following: A term excluding or limiting liability for loss or damage arising from negligence (except death or personal injury) must be reasonable. A term excluding or limiting liability for loss or damage arising from breach of contract in standard contract terms must be reasonable. Where liability is restricted to a specified sum of money, the party must be able to show that this sum has been determined by considering insurance, the contract price and potential loss.
NOTEBOOK: A pragmatic solution to Configuration Management Tony Stock Configuration Management is a technique usually associated with large scale software and systems development, but is an essential discipline for anyone who is constructing even the simplest piece of operational software. The solution to the problem on major projects may
©1994 Elsevier Science Ltd