Liability for lost profits and wasted expenditure: what can you exclude?

Liability for lost profits and wasted expenditure: what can you exclude?

Overview

Commercial contracts can often provide that all liability for loss of profits is excluded – and sometimes wasted expenditure may be excluded as well.  But what is the impact of this in practice?  A recent Court of Appeal decision highlights the potential for confusion, as well as the substantial sums that can be at stake.  In this case, which concerned a dispute over a failed IT project, it came down to whether the customer could recover £80 million – or a rather more modest £12.9 million.

CIS General v IBM: the first instance ruling

CIS General, a provider of home and motor insurance (now renamed Soteria), contracted with IBM for the provision of a major new IT system.  A dispute arose because the project suffered repeated delays and was described by the trial judge as "a failure" offering "little or no value" to CIS General, which by this point had incurred costs of over £120 million.  The judge also concluded that IBM was in repudiatory breach.  However, all but £15.8 million of CIS General's claim against IBM was found to be excluded, primarily because the contract contained a blanket exclusion of "loss of profit, revenue [and] savings (including anticipated savings)".  Once IBM's claims for certain payments were taken into account, the damages award was reduced further to a mere £12.9 million.

Before turning to the Court of Appeal's ruling, it's important to understand why the trial judge thought that so much of CIS General's claim was excluded.  This essentially came down to the view that she took of the meaning of "loss of profits" and whether those words could also exclude a claim for "wasted expenditure".

Lost profits vs wasted expenditure

Damages in contract law protect "expectation loss";  in simple terms, this is the difference between the benefits you would have expected to receive if the contract had been performed properly and what you have actually ended up with.  Customers in cases such as this one typically have a choice as to how they frame their claim.  One option is to claim for their loss of profit.  This may be relatively straightforward in a case for say, non-delivery of goods which you expected to resell at a 5% profit margin – your loss will consist primarily of that 5% margin.  However, claiming on this lost profits basis can become a much more speculative exercise in the case of say, an IT system, whose real value may lie in its ability to deliver benefits such as efficiency savings.  These are often much more difficult quantify in precise monetary terms.  In recognition of this problem, the law allows claims for contract damages to be brought on an alternative basis which focusses on wasted expenditure.  With something like an IT system, this is often much easier to quantify – for example, in this case, CIS General could point to the sum of over £120 million that it had spent so far on trying to procure a working IT system.  Such claims are, however, subject to certain limits. In particular, if the defendant can show that you are claiming more money in costs than the value of any benefits you could ever have derived from having a working IT system, then the court will lower the award accordingly.

CIS General brought its claim against IBM on a wasted expenditure basis.  The trial judge took the view that, as this was merely an alternative to the "classic" lost profits claim for contract damages, it was excluded by IBM's reference to "loss of profits".  As a result, she concluded that the vast majority of CIS General's claim was excluded.

The Court of Appeal's ruling

The Court of Appeal disagreed.  Critically, it did not share the trial judge's view that the phrase "loss of profits" effectively meant the same thing as "wasted expenditure", merely because the latter can be used as an alternative way of framing a claim for contract damages.  It noted that the ability to bring a claim on the "wasted expenditure" basis is a very valuable right (especially where the contract states that the ability to claim for lost profits is excluded).  If IBM had wanted to exclude such a valuable right completely, then it should have spelled this out much more clearly in the contract.

More generally, the Court of Appeal noted that if CIS General could not bring a claim for "wasted expenditure", almost all its claim for loss of bargain would be excluded – and IBM would have almost no liability for serious under-performance.  It did not think that the parties could have intended such an extreme and arguably surprising outcome.  This was a further reason for refusing to give the words "loss of profit" the broad interpretation adopted by the trial judge.  As a result, the Court of Appeal found that the bulk of CIS General's claim was not wholly excluded.  This meant that it could claim damages up to the level of the relevant contractual cap of just over £80 million.

What if "wasted expenditure" had been expressly excluded?

In its discussion of this case, the Court of Appeal referred to its earlier ruling in Kudos Catering v Manchester Central Convention Complex (2013).  This involved an exclusion which referred expressly to both loss of profits and wasted expenditure – although the actual claim related to loss of profits, rather than wasted expenditure.   Read broadly, that claim appeared to be excluded by the clause.  However, the dispute was over premature termination of a fixed term agreement – and the claim was for the profits that the claimant catering provider would have made over the remaining term.  The Court Appeal made the point that excluding any claim in relation to such an important aspect of the parties' bargain would require very clear wording – whereas in Kudos the wording was contained in a clause dealing primarily with indemnities and insurance.  The key point to note here is that even where there is an express exclusion of a particular category of loss, the courts may not be prepared to accept that the parties intended that to apply in a way which leaves the innocent party with little or no meaningful remedy for a very serious breach. 

What about UCTA?

Neither the first instance ruling nor the Court of Appeal's judgment contain any discussion of the Unfair Contract Terms Act 1977 (UCTA).  However, the fact remains that UCTA can be used to challenge exclusion clauses;  it could be relevant in situations where, for example, the wording was felt to be clear enough to "clear the hurdle" set by the common law rules on interpretation such provisions (unlike the position in this case).  Of course, it may be that in such a scenario, the courts would conclude that the parties must have appreciated the impact of the exclusion - and therefore it would be inappropriate to intervene under UCTA.  However, awareness of the extent of the term is only one of the relevant factors under the legislation.  A court could still decide under UCTA that, taking account of all the circumstances, an exclusion of loss of profits and/or wasted expenditure was unreasonable and therefore void - particularly where the clause would drastically curtail any meaningful remedies for serious breach (as would arguably have been the case in both CIS General and Kudos if the exclusion had been given a wide meaning).

What are the key lessons when drafting liability clauses?

According to a report in the insurance trade press, IBM has indicated that it intends to appeal – so this may not be the last word on the matter.  However, the Court of Appeal's approach seems to us to be more in line with previous case law on liability clauses than the first instance ruling. Assuming that the Supreme Court follows a similarly orthodox approach, the key lessons from this dispute are as follows:

Key lessons for customers
  • Where possible, resist attempts by the supplier to exclude "wasted expenditure" or "wasted expenses", particularly where loss of profits is excluded – although remember that the analysis is heavily context-dependent and the courts may be prepared to take a narrow view of what was intended to be excluded.

  • Consider carefully whether you can accept an exclusion of "loss of profits". If you can still bring a meaningful claim on the "wasted expenditure" basis, then you may be able to live with loss of profits being excluded. If, on the other hand, lost profits are the main category of loss that you are likely to suffer (as in the Kudos case), then you should look to limit the scope of any exclusion to indirect loss of profits.

  • Consider including a provision stating that, notwithstanding any exclusions elsewhere, you can recover certain types of loss, subject to the upper limit imposed by any global cap on liability. At the same time, make sure that you can live with not being able to recover more than the amount specified in any such cap, as these will usually be upheld.
Key lessons for suppliers
  • Be aware that the courts may construe exclusions of both "loss of profits" and "wasted expenditure" narrowly; it is always preferable to ensure that you have a freestanding global cap on liability set at a level which you can live with (as opposed to relying heavily on exclusions of this type).

  • Consider the impact of any exclusions on the customer's remedies, especially if you are seeking to exclude both loss of profits and wasted expenditure. Contracts which do not allow the customer at least some form of meaningful remedy for the most serious and/or common types of loss may be vulnerable to being interpreted very narrowly or to challenge under UCTA. 

  • If you genuinely intend the customer to have extremely limited recourse in the event that anything goes wrong, this needs to be made abundantly clear in the contract. You should consider carefully how you would justify this commercially (e.g. perhaps the customer is paying a very low price for the product/service) with a view to satisfying the court that it represents a plausible and reasonable commercial bargain.
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