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Tech project dispute shines light on contractual limitations of liability

Posted: 27/09/2021

The recent case of CIS General Insurance Limited (CIS) v IBM United Kingdom Limited (IBM) [2021] EWHC 347 (TCC) concerned a large IT system implementation. CIS appointed IBM under a master services agreement (MSA) to supply a new system at a substantial cost.

The implementation phase did not go well, culminating in CIS refusing to pay an IBM invoice of around £3 million citing poor performance and missed milestones. As a consequence, IBM served notice to terminate the MSA for non-payment. 

CIS claimed that IBM had no right to terminate the MSA because payment of the invoice was not properly due and as such IBM’s termination notice itself amounted to a repudiatory breach of contract by IBM.  

The judge held that CIS had validly terminated the MSA on the basis of IBM’s repudiatory breach and went on to consider CIS’s claim for damages.

Expectation loss v reliance loss

Where a party terminates a contract for repudiatory breach, an award of damages should place that party in the position it would have been in had the contract been properly performed. The two alternative measures of loss are:

  1. Expectation loss (looking to the future) - the financial benefit expected from the contract had it been properly performed (e.g. increased profits and future cost savings); and
  2. Reliance loss (looking to the past) - the wasted costs incurred in expectation of the financial benefit (e.g. sums paid to the supplier, other third parties and management costs).

The nature of CIS’s claim

CIS’s primary claim was for ‘wasted expenditure’ in the sum of £128 million. This was made on the ‘reliance loss’ basis, as opposed to the ‘expectation loss’ basis (e.g. additional costs of obtaining a replacement system from an alternative provider).

The key question before the court was whether the claim for ’wasted expenditure’ was excluded by the exclusion clause in the MSA, which provided that:

“…neither party shall be liable to the other… for any loss of profit, revenue or savings … (in all cases whether direct or indirect)…”

IBM argued that although the claim referenced expenditure incurred (a ‘reliance loss’), the claim was actually for the lost profit, revenue or savings through which that expenditure would have been recouped, but for the breach. In which case, the exclusion clause should apply.

By contrast, CIS argued that its claim was not for a loss of profits but simply wasted expenditure to date, which is being claimed to put it into a ‘break-even position’.  In which case, the exclusion clause should not apply.

The court’s decision

The judge concluded that the contractual benefit to CIS, which had been lost due to IBM’s breach, was the profit, revenue and savings that would have been achieved had the system been successfully implemented. The new system would have improved CIS’s competitiveness within the market, resulting in increased profits, revenues and savings for CIS.

A claim quantified in the amount of those lost profits would be excluded by the exclusion clause in the MSA.  Re-framing the claim as one for ‘wasted expenditure’ did not change the characteristics of the losses for which compensation was sought. It was merely a different method of quantifying the same loss.

That conclusion was surprising here, particularly given case law has so far tended to limit the application of a loss of profits-type exclusion to a loss of future profits rather than the immediate costs of getting a project back on track.

Despite the claim being for in excess of £128 million, the court awarded CIS just £16 million based on other costs incurred due to IBM’s delay in achieving contractual milestones.  The court held that the £3 million invoice was payable by CIS. However, because it was disputed correctly by CIS according to the MSA procedures, its non-payment did not entitle IBM to terminate.  The court allowed the £3 million invoiced amount to be set off by IBM against the £16 million claimed by CIS.

Key takeaways from the decision

This decision is concerning from a technology customer perspective. It seems likely here that the parties intended that claims for future potential loss of profits be excluded by the liability clause in the MSA. However, in our view it seems unlikely that they intended the loss of profits exclusion to also cover wasted expenditure incurred to date. It remains to be seen whether CIS appeals.

This case serves as a timely reminder to those involved in IT projects to pay very careful attention to the limitations of liability in the contractual documentation.

Given the court found here that a loss of profits exclusion also covered wasted expenditure, going forward any potential ambiguity around whether particular heads of loss are recoverable (or not) ought to be tackled head on in the drafting. If a customer expects to recover wasted expenditure, then that should be agreed at the outset and expressly stated in the contract. If a supplier expects claims for wasted expenditure to be excluded, then it would be wise to expressly state that in the contract rather than hope that the loss of profits exclusion covers it, as it did do here (to the surprise of many technology lawyers). 

Investment at the negotiation and drafting stage is likely to be money well spent by the supplier if it can point to a clear list of excluded heads of loss, or by the customer if it comes away with a comprehensive list of “deemed” direct recoverable losses. 

This article has been co-written by Nilly Tabatabai, Associate – IP, IT and Commercial

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