What happens when your software development contract turns sour?

10 minute read
25 October 2023

The recently reported High Court case Topalsson GmbH v Rolls-Royce Motor Cars Ltd [2023] EWHC 1765 (TCC) delivers an interesting legal overview of the breakdown in a software development contractual relationship.

In this update, we summarise the case and provide some points to note in relation to entering into and terminating contracts, while also considering what this means from a contract interpretation perspective.

What happened?

Under a services agreement, Topalsson agreed to develop and supply digital visualisation software to Rolls-Royce to replace what was in existence already. A tender process had preceded and the plan was for the software to be operating in time for the launch of the new Rolls-Royce Ghost model in spring 2020. The new software would allow prospective customers of Rolls-Royce to view envisaged car configurations from 3D models.

As can often happen in projects, delays occurred and milestones were not met. The causes of the delays were disputed and the parties blamed each other.

Topalsson argued that Rolls-Royce imposed a waterfall implementation methodology, which was not the right choice to achieve results in the customer's tight timescales, and consequently created delay. It argued the scope of the project had expanded, and that Rolls-Royce refused to agree a billing plan. Its case was that time was not of the essence, as there was no agreed programme; its obligation was simply to deliver within a reasonable time.

Rolls Royce's case was that Topalsson had failed to resource the project adequately, performed poorly and was significantly in delay. Its view was that Topalsson agreed to complete services and deliver the software packages at a fixed cost by the milestone/delivery dates identified in an agreed programme. As a consequence, Rolls-Royce lost confidence in Topalsson's ability to perform.

Damages claimed

Topalsson claimed damages for unlawful termination, quantified as lost profits in the sum of €6,420,793 or alternatively €2,420,793 in respect of work carried out and/or invoiced at the date of termination. Rolls-Royce counterclaimed damages flowing from the contractual breach. It claimed that it suffered loss and damage amounting to €20 million in respect of replacement software, lost profits and other heads of claim.

It was undisputed that the contract contained an effective limitation of liability, capping both parties' contractual claims at €5 million.

What the judge decided

O'Farrell J found that Topalsson was under a contractual obligation to achieve what was termed 'Technical Go-Live' by certain agreed dates. In particular, that a revised scope was contractually binding on Topalsson and made time of the essence for the revised dates agreed. Technical Go-Live had not been achieved by those dates. She found that Topalsson was not impeded in its performance, or prevented from performing its obligations by Rolls-Royce, and that Rolls-Royce was entitled to terminate under the agreement on the ground of Topalsson's repudiatory or anticipatory breach. Rolls-Royce was awarded damages in the sum of €5 million plus interest.

Five takeaways from Topalsson for IT contracts and beyond

1. Appropriate IT methodology - waterfall or agile?

In this case, a key issue during the tender phase was which implementation methodology ought to be used, and discussions on this continued as the project started to encounter difficulties. Topalsson had met the tender requirements by agreeing to a waterfall approach, which was Rolls-Royce's preference. The agreed contract reflected this. However, Topalsson felt strongly throughout that an agile approach would have been better suited, and post-contract argued that the approach should change. This continued to be one of the causes of the breakdown in the commercial relationship, highlighting the importance of parties to a contract being clear as to the bargain they have signed up to.

2. Clear contract

As set out in our article on top 10 tips for managing contractual disputes, our number one piece of advice will always be to have a contract in place from the outset that accurately reflects all terms agreed between the parties. In this case, disputes arose regarding the milestone dates and what was meant by Technical Go-Live, and therefore what Topalsson was required to do to achieve it. It's important to put key dates in the contract and keep any implementation plan under review. If there is change, record it by fully employing the contractual variation or change control mechanism.

If time is to be of the essence, the optimum approach is to include a clearly drafted clause in the agreement and ensure it aligns with the termination provisions (see below regarding the court's analysis arising out of the dispute over timescales in this case).

3. Interpretation of the contract

The court applied now well-established principles on contractual interpretation to the facts of this case, and the judgment is a valuable reiteration of how the court will approach interpreting the construction of your agreement in the event of breakdown. The court will 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 in interpreting the language used in the contract. It does so by focusing on the meaning of the relevant words in their documentary, factual and commercial context.

So, in interpreting the wording of the performance obligations clause, where it was stated "time is of the essence", O'Farrell J considered not only the actual wording of that clause, but also other provisions which made it clear that delivery dates were fixed as part of the first phase of work under the agreement. The deadlines were set out in a high-level implementation plan and were to be further specified in another delivery document. Once milestone dates were agreed in that document, those were the specified dates under the agreement.

The material provisions must be construed against the factual matrix. It was clear from the outset that the new configurator was required to be functioning for the launch of the Ghost model. Those commercially sensitive dates were identified in the implementation plan, contained in the Invitation to Tender appendix and in all subsequent versions of the Roadmap and other plans produced by Topalsson. Against that background, the court held that it was the parties' common understanding that strict compliance was required with the agreed milestone dates.

4. Receiving and drafting termination notices

The court found that a first termination notice served by Rolls-Royce was erroneous because it relied on Topalsson missing the original delivery deadlines, when these had already been superseded by a revised plan. This was ultimately immaterial as Topalsson affirmed the agreement in response.

A few days later, Rolls-Royce served a second termination notice terminating the agreement both for: (i) repudiatory breach under common law on the basis that time was of the essence in relation to achieving the revised milestone dates; and (ii) under a clause of the agreement that permitted immediate termination if Topalsson failed to meet the agreed delivery or milestone dates.

The court found that Rolls-Royce's second termination notice was valid and Rolls-Royce had been entitled to rely on either basis for termination as Topalsson's delays were significant.

Parties wishing to terminate a contract for repudiatory breach should make clear, in the notice of termination, the valid and factual reason for terminating the contract. See point 4 in our top 10 tips article for more advice on understanding your position in this context. If revised scope or delivery dates have been agreed, any termination notice referring to original dates may be invalid. A party serving an invalid notice may be in repudiatory breach itself, opening a clear path for the innocent party to claim damages instead.

Equally, those in receipt of termination notices should take legal advice. Often decisions need to be made quickly and mistakes in this context could be costly.

5. The relationship between set-off clauses and damages claims

Damages awarded for breach of contract are compensatory, intended to give effect to the contractual bargain. The agreement between Topalsson and Rolls-Royce reflected the usual 'net loss' approach to damages i.e. any gains resulting from the breach (such as savings made in not carrying out future performance) are set-off against expenses caused by the breach (such as cost of replacement) and gains prevented by the breach (such as loss of profits).

The court rejected Topalsson's argument that the sums due to it (held to be €794,959) should be set off after the contractual €5 million liability cap had been applied. The court held that the set-off exercise should be undertaken first, with the effect that Topalsson owed Rolls-Royce €7,167,564. That was capped at the agreed €5 million.

These key takeaways highlight the importance of taking a proactive approach to avoiding the potential cost and negative impact a dispute can bring for a business and its commercial relationships. The overarching message is always about dispute avoidance and a key element here is drafting a good contract which provides clarity on the goods and services being delivered and set outs clear procedures should issues arise.

For more insight on this topic, listen to our ThinkHouse session on what to do when contracts go wrong. Should you wish to discuss any of the points raised here further, please get in touch with Patrick Arben or Louise Macdonald in our Commercial Litigation team.

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