Unfair Contract Terms - Application to Technology and Software Contracts

Technology Contracts

Due to the differences in the application of the to B2C and B2B contracts, it is sensible to consider preparing different contracts for consumers and businesses with regard to the nature of the product or services sold. As may be drawn from the foregoing state of the law in the UK, consumer contracts attract a higher level of protection in comparison to business contracts.

The law as it applies to technology and software has been set in place by two cases.

Watford Electronics v Sanderson EFL Ltd

The Court of Appeal held that B2B are of a different status to consumer contracts and intervention may not be warranted as frequently on the grounds of reasonableness.

The clause read which formed the substance of the dispute read as follows:

"Neither the Company nor the Customer shall be liable to the other for any claims for the indirect or consequential losses whether arising from negligence or otherwise. In no event shall the company’s liability under the Contract exceed the price paid by the Customer to the Company for the Equipment/Software for the claim."

Thus the exclusion clause purported to exclude liability for all indirect and consequential losses suffered by the customer, including that suffered by way of negligence by the party alleging the breach and purported to limit liability to the price paid by the customer.

The Court of Appeal affirmed the freedom of the parties to contract on the terms agreed between them. The Court stated that the reasonableness of the clause depended on the scope of application of the clause. The parties’ agreement reflected that the clause was limited to contractual and negligence liability and was not simply limited to liability for misrepresentation.

It was found that clauses of this type were common in contracts for software supply, and customers seeking exposure from suppliers for a higher level of liability were usually required to pay a premium to cover the additional insurance that supplier requires to cover the risk.

The considerations that the Court took into account in upholding the exclusion of indirect and consequential losses were:

• if the software failed, the customer would feel significant impact to their trading activities and their bottom line
• the customer was in a better position to assess the potential loss to its business if the software failed to perform
• the risk of the software failing to perform was insurable and that risk of loss was accounted for in the contract price, and
• the custom built software as opposed to standard software carried greater risk to the supplier.

In the circumstances where the parties were of similar bargaining power, the court would be slow to move to interfere with an allocation of risk between the parties.

Importantly, the Court’s rationale for finding the exclusion clause was enforceable lay on the basis that the parties had agreed levels of damage in the event of a breach of contract: that value was the price of the goods supplied, which under the Sale of Goods Act 1979 was determined to be calculated by the difference of the value of goods of an acceptable quality and the defective goods.

The case did not deal with excluding or limitation of consequential losses resulting arising from pre-contractual statements. Most software licenses and projects are entered into on standard terms without negotiation. This was not the case in this dispute.

The Unfair Contract Terms Act applies to standard agreements despite the fact that they have been negotiated. The test of reasonableness relies on the facts of the case. Lower courts were warned that courts should be ‘very cautious before reaching the conclusion that the agreement which … [the parties] …. have reached is not a fair and reasonable one’.

SAM Business Systems Limited v Hedley & Company

SAM was a software house in the business of supplying and maintaining software for the stockbroking industry, known as InterSet. A money back guarantee contained in the software license applied in certain circumstances, and was accompanied by an ‘entire agreement’ clause and an exclusion of liability clause. Specifically, the licence agreement contained clauses to exclude warranties of fitness for the purpose and damages resulting from the use of the software.

Hedley was a stockbroking business based in Lancashire that was looking to upgrade from a DOS system to run its client lists and back office functions. Hedley was under pressure to upgrade for Y2K compliance. On go-live problems persisted, Hedley changed system in May 2001 and issued proceedings for the losses sustained by the failure of the software. For Hedley, the dispute did not stop with financial losses. Failures of the implementation of the system led to investigations by the Financial Services Authority and a loss of confidence of Hedley’s clientele in the services they provided.

In the course of proceedings brought by SAM, the High Court was considered whether:

• section 3 of the Unfair Contract Terms Act applied to the entire agreement clause
• the entire agreement and exclusion clauses were reasonable under the UCTA, and
• SAM was entitled to recover sums due under a main agreement for rectifying defects in the software, if liability for damages arising out of the defects could be recovered or exclusion clause prevented recovery.

The Court held that the entire agreement clause cannot be used by a software or technology supplier to deliver a substantially different contractual performance than that contemplated by the customer. The exclusion and entire agreement clauses were reasonable, on consideration of the large contingent liabilities facing the supplier. Crucial was the presence of the money back guarantee. Without it, the exclusion clause would have been invalid. Capping of liability with reference to the sums payable under the contract for supply was a lawful contractual method to limit liability and would have been a reasonable measure to cap liability even without the money back guarantee.

Other factors were found to be relevant – the equal bargaining position of the parties, the fact that SAMs’ competitors use similar exclusion clauses, and that Hedley acquiesced to the provision of the software as they did not seek to negotiate better terms for exclusion of liability. The more standardised a software package is, the less tolerance a court will be in relation to defects in it. There was customisation work done on Hedley’s system, so their persistence with the product and the request for development militated against them. As bugs were present at the time of delivery the court did not allow recovery of fees charged by SAM for rectifying bugs in the software. This was despite a maintenance agreement that entitled them to charge for resolving problems with the software. The Court’s basis for doing so was that SAM would otherwise be entitled to profit from their own breaches of contract.

Software sold as a tried and tested system should not contain bugs, so SAM was not entitled to be paid for rectifying those defects, particularly in light of the fact that they had excluded liability for them.

In effect, Bowsher J commented that a customer should not be liable to pay for rectification of defects existing at delivery, whether or not a contractual limit on liability existed under the contract. The judge said, “Exclusion clauses exclude liability for breach of contract: they do not amount to an agreement that performance has been given by providing equipment that is fit to be maintained: nor do they amount to an agreement that the purchaser should pay for any efforts made by the supplier to put right the defects”.

What Business Should Do

It is critical for businesses in contracts for software to incorporate specific provisions as to the deliverables and statutory requirements in the acceptance testing benchmarking for a computer system that escape the reach of blanket exclusion clauses. Failing to do so puts the entire purpose of implementing new computer systems at risk and consequent damage may not be recoverable in the worst case. Entering into a software licence or software development project is fraught with difficulties as the Unfair Contract Terms Act is one legislative instrument that does not so much create certainty at the same time as create this supervisory jurisdiction for the Court in creating remedies for unfair contract terms for licensees

In contracts where a right of rejection does exist, it should be exercised promptly for two reasons - first to mitigate the damage incurred by the software, and secondly to avoid the argument that substantial benefit has been obtained from the use of the software. Hedley used the software for some 17 months prior to exercising their contractual right to reject the software – termination and demands for rectification should clear, unequivocal and prompt.