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Exclusion clauses: Wasted expenditure distinct from loss of profit, says Court of Appeal

A-lawyer-or-businessman-is-stamping-on-a-contract-document Print publication

12/04/2022

In a key judgment, the Court of Appeal has reversed a controversial High Court decision and held that a loss of profit exclusion in a contract did not exclude a claim for wasted expenditure. At least £80 million turned on the construction of that one clause. Sally Mewies and Gwendoline Davies, Partners in Walker Morris’ Technology & Digital and Commercial Dispute Resolution Teams, consider Soteria Insurance Limited v IBM United Kingdom Limited [1] and the judgment’s practical implications.

What practical advice arises?

Pending a potential appeal by IBM to the Supreme Court, this judgment provides welcome clarity. Taking into account the Court of Appeal’s reasoning (see below), and the potentially significant cost implications of getting things wrong, commercial parties should draft the exclusion clauses in their contracts with care.

While common sense has been restored, this case demonstrates the dangers of using templated exclusion clauses in all cases without careful consideration of the losses that are likely to be incurred if there is a serious breach. It won’t be possible to change this pattern of behaviour in many business as usual contracts because it has become so commonplace, but in high value strategic agreements more thought and perhaps different language should be considered.

Parties seeking to exclude or limit liability for wasted expenditure claims should include express wording to that effect and think carefully about tailoring their wording/including specific definitions in the context of the particular transaction – what types of loss might arise and what exactly is it that you are seeking to exclude?

Given the court’s reference to an earlier case [2], where the draconian consequences of a clause expressly excluding liability for “revenue or profits, anticipated savings or wasted expenditure…” in circumstances of wrongful repudiation led the court to restrict the clause only to defective performance, parties intending exclusions to apply in instances of repudiation may also wish to provide for this expressly in their drafting.

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What was the case about?

The parties entered into a contract under which IBM was to supply and manage an IT system for CIS General Insurance Limited (‘CISGIL’, now Soteria). The system was very late and ultimately not delivered. A dispute arose over a £2.9 million invoice from IBM. The invoice was not paid and the contract terminated.

The High Court held, among other things, that IBM had wrongfully repudiated the contract and that CISGIL had consequently established a claim for wasted expenditure, valued at £122 million. However, that claim was excluded in its entirety by operation of the clause in the contract which excluded liability for “loss of profit, revenue, savings (including anticipated savings)”.

In reaching that conclusion, the High Court said that CISGIL’s loss of bargain suffered as a result of IBM’s repudiatory breach comprised the savings, revenues and profits that would have been achieved had the IT solution been successfully implemented, and that a conventional claim for damages in this type of commercial case would usually be quantified based on those lost savings, revenues and profits. CISGIL was entitled to frame its claim as one for wasted expenditure but that simply represented a different method of quantifying the loss of bargain; it did not change the characteristics of the losses for which compensation was sought.

The proper construction of the exclusion clause was the primary issue for the Court of Appeal to resolve.

What did the Court of Appeal decide?

The Court of Appeal reversed the High Court’s decision for the following reasons:

  • Applying the principles of contract construction [3], claims for wasted expenditure (costs actually incurred but wasted) were not referred to in the clause and, on the natural and ordinary meaning of the words, were not included in “loss of profit, revenue [or] savings”. The fundamental difficulty was that the words were simply not there. In addition, the clause contained a good deal of particularity as to what types of loss were being excluded from the otherwise wide definition of losses in the contract. They included not only loss of profit, revenue or savings, but also loss of data, goodwill and reputation. The parties’ decision not to exclude claims for wasted expenditure was therefore telling.
  • Clear language was needed to exclude such an obvious remedy. The more valuable the right, the clearer the language of any exclusion clause will need to be; the more extreme the consequences, the more stringent the court must be before construing the clause in a way which allows the contract-breaker to avoid liability for what may be their catastrophic non-performance. There was nothing in the clause to suggest that the costs which CISGIL inevitably incurred in the expectation that the project would be completed satisfactorily, would somehow be irrecoverable if IBM repudiated the contract.
  • When a contract is repudiated, the victim can claim loss of profits or the expenditure which has been thrown away as a result of the repudiation – they cannot claim both. All loss of profit/revenue/savings claims are difficult for the potential contract-breaker to estimate in advance. They can be notoriously open-ended. Such claims are therefore types of potential loss which, because of those problems of speculation and ascertainment, are routinely excluded by clauses like the one in this case. Claims for wasted expenditure are “an entirely different animal”. To be able to claim such wasted expenditure is a valuable right. If the victim of a breach of contract has spent money in anticipation that the contract would be performed, then their loss is easy to ascertain through invoices, contracts, receipts, and so on. This type of loss is the opposite of speculative: it is precisely ascertainable. It was unsurprising from a commercial perspective that, while speculative and uncertain types of loss were excluded by the clause, at least one kind of easily-ascertainable type of loss – wasted expenditure – was not. The claims that would have compensated CISGIL for being better off as a result of the new IT system were excluded; the claims to compensate them for being worse off as a result of the non-provision of the system were not.
  • It was fundamentally incorrect to say that CISGIL’s loss of bargain was solely represented by lost profits, revenue and savings – the primary thing which had been lost was the provision of the new, improved IT system. It would be wrong to suggest that the clause excluded all claims for loss of bargain – the clause was seeking to exclude some of the types of loss which flow from an underlying loss of bargain, but not to exclude other types of loss which arise from that same lost bargain. Some types of loss of bargain damages, like loss of profit, revenue or savings, were excluded. Other types, such as re-procurement costs and wasted expenditure, were not.
  • Characterising “wasted expenditure” as a method of calculating “lost profits, revenues or savings” was an unjustified leap of reasoning by the High Court. While lost profits (or revenue or savings) is one method of calculating damages for the loss of bargain, a claim for wasted expenditure is simply a different method of calculating such damages. That does not make wasted expenditure a method of assessing or claiming lost profits (or revenue or savings). They are different types of claims.

 

Our large team of experts are here to help with any queries you may have in relation to contract drafting or dispute resolution options and strategy. Please get in touch with Sally Mewies and Gwendoline Davies, Partners in Walker Morris’ Technology & Digital and Commercial Dispute Resolution Teams.

 

[1] [2022] EWCA Civ 440

[2] Kudos Catering (UK) v Manchester Central Convention Complex Limited [2013] EWCA Civ 38

[3] See this earlier briefing for a summary of the approach to contractual interpretation and the relevant case law

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