In a recent judgment, the Court of Appeal considered the proper construction of a clause that excluded liability for, among other things, "loss of profit, revenue [or] savings". The question (on which £80 million turned) was whether that clause also excluded a claim for wasted expenditure. We consider the impacts of the judgment in different sectors.

Summary

  • When construing a contract, the court must consider the natural and ordinary meaning of the words used by the parties.
  • Very clear words will be required to exclude liability – the more valuable the right, the clearer any exclusionary wording needs to be.
  • Although wasted expenditure and loss of profit both seek to compensate a claimant, they are not the same. Clear words will therefore be needed to exclude liability for both.

Background to the case

The case concerned a contract for the supply of an IT system. The system was delayed and, ultimately, not delivered. Towards the end of the contract, the supplier terminated the contract for the customer's non-payment of a £2.9 million invoice. The customer claimed that the invoice was disputed owing to the delays to the project, and so the supplier's termination for non-payment was a wrongful repudiation. The customer claimed damages of £132 million representing its wasted expenditure.

In a substantial first instance decision, O'Farrell J found that the supplier had wrongfully repudiated the contract, and that the customer had, in principle, established a claim for wasted expenditure. However, she also found that the customer's claim for wasted expenditure was entirely excluded by the exclusion clause in the contract.

The customer appealed the judge's findings on the construction of the exclusion clause.

Did the clause exclude wasted expenditure?

The exclusion clause in question excluded liability for "indirect or consequential Losses, or for loss of profit, revenue, savings (including anticipated savings), data…, 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".

The Court of Appeal held the judge was wrong to find this clause excluded the customer's wasted expenditure claim for five reasons:

  • Reason 1 – Natural and ordinary meaning of words used – the court must start with the words actually used by the parties. "Wasted expenditure" simply did not appear in the words of the widely drafted exclusion clause, and the natural and ordinary meaning of the words "loss of profit, revenue, savings" was not apt to cover it. The court also noted that while the parties went into some specificity in the clause (e.g. by excluding liability for loss of data), they did not also choose to specify wasted expenditure. The court said the principles of construction led inexorably to the conclusion that the parties did not therefore intend to exclude liability for wasted expenditure.
  • Reason 2 – Clear language is required to exclude an obvious remedy – related to this, the court noted that, when construing an exclusion clause, "[t]he more valuable the right, the clearer the language of any exclusion will need to be". The court considered that the customer's claim for expenditure wasted in the expectation of receiving the new IT system was arguably the most likely claim which could have arisen from the contract. To exclude that claim, any exclusion therefore needed to be clear and obvious. Here though, there were no exclusionary words, let alone clear and obvious ones. "On one analysis", said the court, "that is the end of the construction point. Claims for wasted expenditure were not excluded because those words do not appear in the relevant exclusion clause." However, they found that conclusion was also supported by an analysis of the various types of loss referred to in the clause.
  • Reason 3 – Different types of loss – the court noted that "loss of profit, revenue, savings" (as framed in the exclusion clause) are losses of a similar kind – they are forms of consequential loss, predicated on the hypothetical and counterfactual scenario that the contract had been performed. The court said these types of loss are routinely excluded in parties' contracts because they are difficult to assess. Wasted expenditure on the other hand is a valuable right that is precisely ascertainable – calculating a party's expenditure is a pure accounting exercise. On this analysis, the drafting of the clause excluded those claims that would compensate the claimant for the benefits it expected to derive as a result of the new IT system (loss of profits etc); but did not exclude claims to compensate the claimant for being worse off as a result of its non-provision (i.e. its wasted expenditure).
  • Reason 4 – Loss of bargain – the primary bargain the customer had lost was not (as the judge had said) the lost profits, revenue or savings the IT system could have generated, but the IT system itself. While the clause excluded loss of profit, revenue or savings, it did not operate to exclude other types of loss such as the cost of re-procuring the IT system from another supplier, or the customer's wasted expenditure. If it were otherwise, the claimant would be left with limited recourse for the loss of its bargain, which would be a draconian result.
  • Reason 5 – Inconsistent with previous decision – finally, the court noted that, in reaching her first instance judgment in this case, O' Farrell J had been forced to distinguish one of her own previous decisions. In that earlier decision, she had found that a similar clause excluding an IT supplier's liability for loss of profits, revenue or anticipated savings had not excluded a health trust's claim for wasted expenditure because wasted costs compensated the trust for the loss of the bargain, and were not a claim for loss of profits. The Court of Appeal found the judge's attempt to distinguish the two cases unpersuasive – "[i]t would mean that the interpretation of the same words in the same contract would mean something completely different, depending on the identity of the employer and whether it was a profit-making company or not. It would be the opposite of providing the clarity required to construe an exclusion clause." The Court of Appeal found that the judge's earlier decision was correct, and the same outcome adopted in this case.

For all the above reasons, the court concluded the judge's construction of the exclusion clause was erroneous, and the claim for wasted expenditure was not excluded.

What are the implications of the decision?

The first instance decision in this case had caused some consternation for those involved in drafting exclusion clauses, as it left the claimant with limited remedy for wrongful repudiation. This Court of Appeal decision provides some welcome clarity and reiterates key principles of contractual construction enunciated by the Supreme Court in recent years:

  • Words matter - the court is primarily concerned with the natural and ordinary meaning of the words actually used by the parties. If the parties have used unambiguous language, the court must apply it.

  • Exclusions must be clear – if the parties intend to exclude liability for wasted expenditure (or anything else), then they should do so in clear terms. The more valuable the right being excluded, the clearer any exclusion clause needs to be.

Ashley Pigott, partner - Construction & Engineering:

Although the main issue in this case was the construction of the exclusion clause, there was also some interesting discussion of whether the supplier's unpaid invoice was properly disputed within the meaning of the contract (if not, then the supplier may not have wrongfully repudiated the contract). The court noted that the contract contained "pay now, argue later" provisions of the sort that underpin adjudications in the construction sector.

The Court of Appeal upheld the judge's findings that the invoice was formally disputed in good faith – there was no need for the customer to use the word "dispute", or to invoke a particular procedure; "we cannot accept this invoice for payment" was enough to register a dispute, and since the invoice was disputed, the supplier had not been entitled to terminate the contract for non-payment. Although it was academic because the court found the invoice was properly disputed, it also found that the "pay now, argue later" regime in the contract would have prevented the customer relying on set-off as an alternative reason for withholding payment, as that set-off had not been raised in the timeframes stipulated in the contract.

Helen Davenport, partner - Commercial Litigation:

As O' Farrell J's two contrasting first instance decisions demonstrate, exclusion clauses of this sort are frequently at the centre of IT disputes. As the court recognised, wasted expenditure is arguably the paradigm claim when an IT implementation project runs into difficulty, so if the parties intend to exclude wasted expenditure, that needs to be made explicit.

As well as resulting in an important Court of Appeal judgment on exclusion clauses, the case is interesting more widely as it touches on topical issues in IT disputes including the use of agile implementation methodologies (on which there are still relatively few reported cases) and managing troubled IT projects.

If you have any questions about this article, please get in touch with Ashley or Helen.