CONTRACT LAW OF 2010: WHAT ARE THE CHIEF LEARNING POINTS?

Contract Law is at the heart of so much what we commercial people do – here is an update on the important cases of 2010 and what we can learn from them.

Background

2010 saw a bumper crop of cases from the courts on the subject at the heart of all contracts, negotiations and most disputes as well. By looking at these cases, we can come up to speed on the state of the current law, the latest judicial attitudes to common problems and from this we can update our practice in line with the latest thinking.

We are going to look at the most important cases – not to try and set out everything in them (there would be far too much detail) but just enough to tease out the essential learning points – what you need to know to keep up to speed with best practice.

BSkyB v EDS

Undoubtedly the most biggest IT case in 2010 in very many ways – and we have already covered this case with its learning points at BSkyB v EDS.

De Beers v Atos Origin(2): analysis of a failed IT project

This judgment came at the end of 2010 – the second big IT project to be the subject of judgment together with the BSkyB case. In many ways it is more interesting, and has more to say about how the law applies to failed IT projects.

De Beers is, of course, the well known diamond company and Atos Origin is the well known IT services provider. De Beers wanted a new system to manage its diamond production and selling operations in Africa. The tender was competitive and Atos Origin went through an initial analysis phase, with which De Beers expressed its dissatisfaction, with some negative comments about some of the employees. This was followed by a fixed price contract in November 2007 for delivery in June 2008, but the project got off to a bad start and there were delays.

In March 2008, Atos Origin’s fourth invoice for £325,000 went unpaid and the parties agreed a revised programme in the following month. However, Atos Origin claimed that the scope of the project had moved considerably and proposed an increase over the original price of £2.9m by £4.6m. De Beers refused and Atos Origin threatened to suspend work if De Beers did not agree to a variation to reflect the increased scope of work. De Beers still refused, so Atos Origin walked off site. De Beers accepted this breach as “repudiatory” entitling them to terminate the contract.

In looking at the reasons for the delay, the judge found there was little evidence from Atos Origin to justify their claim that De Beers had caused the delay by their own lack of cooperation. On the question of scope creep, the judge found that the initial analysis phase had not been thorough enough, and it was true that De Beers had not understood or communicated its own requirements sufficiently well. However, the judge found in effect that the commercial risk of this lay with Atos Origin, not with De Beers – it was up to Atos Origin to understand the risks of the project and build in the right contingency. De Beers was entitled to rely on Atos Origin to assess the situation and to contract accordingly. If the contract had insufficient contingency from Atos Origin’s point of view, then this was Atos Origin’s risk.

De Beers v Atos Origin – the Learning Points

After BSkyB, this was the second major case this year where agile and cooperative methods of software development were under the judicial spotlight – and the consequences for the IT industry are not encouraging. Agile methods encourage incremental delivery and cooperative ways of working – but IT contracts are still often expressed as rigid, phased, fixed price, fixed scope affairs, and ill suited to modern development methods. The IT industry needs to find a way to contract for and manage these agile projects in a way that does not leave them open to criticism based on inappropriate methods of contracting.

When it came to explaining the delay, the judge found remarkably little evidence from Atos Origin to justify their criticisms of De Beers. The obvious learning point is to keep an audit trail of delays, and also to make sure there are contemporaneous records evidencing that these points were being raised with the user. Unfortunately, this is one area where legality goes head to head with good customer relations: managing expectations and having evidence are not good bedfellows but are crucial in the long run.

When looking at Atos Origin’s contemporaneous attempts to analyse the project and come up with suggestions for going forward, a valuable suggestion would be to bring together the various disciplines – technical, project management, legal and commercial. Changing the project from agile to waterfall (as happened here) has commercial and legal ramifications, which need to be taken into account rather than being dealt with in isolation as a purely project management issue.

The most important thing to come out of the case is the way that the judge fixed the commercial risk of the project turning out to be much bigger than originally thought fairly and squarely on Atos Origin – regardless of the fact that he found that De Beers had not cooperated as well as it might during the initial analysis phase. Nonetheless, it was up to Atos Origin to recognise the risks, scope the project and price in the right contingency. This has important implications for contracting, as writing in the right assumptions and the consequences for any of those assumptions being wrong must be key to proper contracting. The judge found that the change control provision (drafted as so many such provisions are) only covered genuine additions to the required functionality – it did not cover the whole thing just being much bigger and more complex than anyone thought at the beginning.

The other thing which Atos Origin did wrong here was to walk off site: while there was a contractual provision allowing them to suspend work for non-payment, there was no power to suspend work as a lever to make De Beers pay more money. Atos Origin’s doing so was a really serious breach, in this case a “repudiatory” breach, entitling De Beers to bring the whole contract to an end. The learning point here is to make absolutely sure you are entitled to act as you are proposing – check the contract and any amendments allow you to suspend and ensure that you stay within the strict wording in making any threats.

What happens if you start work without a signed contract?

Are you sure you have a contract at all, and if so, what are its terms? RTS Flexible Systems v Molkerei Alois Müller(3) looked at this question and is very instructive.

IT projects, as in so many other industries, often get started with no signed contract, and have at most something like a “letter of intent” or “heads of agreement” – if anything at all. The parties get started on the project while continuing to negotiate. In those circumstances, so common in so many industries, you would expect the law to be simple to state and easy to apply. This case came out from the Supreme Court in 2010, and most strikingly, each of the trial judge, the Court of Appeal and the Supreme Court came to a totally different conclusion about whether there was a contract and what terms should apply to it.

Why is it important? It comes down to limitations and exclusions of liability. If you have a contract with no terms and conditions, then the supplier will face unlimited liability for its defaults: this is the trial judge’s finding. As against which, if you have a situation where the court finds there is no contract, then there is nothing for the supplier to be in breach of: this was the finding of the Court of Appeal. If you have a contract with some terms and conditions applying, the supplier will normally seek to include some limits on its liability in those terms and conditions for any default: this is in fact the finding of the Supreme Court and it has some very interesting things to say about this most common of situations.

Mueller makes pots of yoghurt and RTS supplies automated packaging systems. There was a long drawn-out tender process, with several iterations of technical specifications, and the parties negotiated over several months about the terms and conditions. An industry standard set of terms called “MF/1” was chosen as the basis, and they included various limitations and exclusions of liability to protect RTS. They also included a fairly standard counterparts provision, stating that the contract would not become effective until each party had signed a counterpart and exchanged it with the other party.

Nothing was ever signed off, though work started under a letter of intent, expressed to last for 4 weeks. Problems were encountered almost immediately, and the parties discussed re-scoping and re-scheduling the work to be done, and agreed on this several months into the project. However, the parties fell out and litigation started.

The Supreme Court took a different line from the other two courts. It said that the parties had impliedly by their conduct waived the requirement for signature as set out in the counterparts clause in MF/1. Accordingly, there was a contract in existence between them and it included the MF/1 terms and conditions (together with the limits and exclusions of liability). The Supreme Court pointed out that it was commercially unrealistic to rely on such a counterparts provision to deny that there was a contract in existence and to argue that neither party had intended to contract. The Supreme Court pointed to the fact that the vast majority of the contract was negotiated to completion and the parties had been acting in reliance on it – including by varying it several months into the project.

RTS v Mueller – the Learning Points

You might like to look our White Paper on the topic of starting work without a contract: Starting work without a contract.

The letter of intent was obvious defective: being realistic, it is necessary sometimes to start or continue work under some sort of letter of intent, but the problem with this one was that it was expressed to last for 4 weeks but did not say what was to happen after that. It invited confusion as to the status of the parties’ contractual relations if it proved impossible (as it in fact did) to finalise the technical specifications and the contract within that period.

It is possible to use some standard wording, such as “subject to contract”, but if you keep using it, the courts may find that your actual behaviour supersedes the meaning of the words, and the result will be that the courts ignore your use of those words. You should consider using a different formula in your correspondence – changing the words will mean that a court is more likely to deduce that you actually mean what you are saying. The downside is that parties are sometimes quite happy to let sleeping dogs lie – better not to rock the boat by raising questions about the existence of the contract. This case, going all the way to the Supreme Court, shows the risks of that approach.

The case signalled a change from the line being taken by the Court of Appeal last year, which was to the effect that the court should not strain to find a contract – the correct answer in many cases might be to find that there was no contract in operation at all. This approach must now be in doubt, and the learning point must be that courts now will be more prepared to find contracts where there is nothing signed off, and that courts will be prepared to find that a purely formalistic use of “subject to contract” or similar words will not be found automatically to be effective.

The battle of the forms – how to win the war

GHSP Inc v AB Electronics(4) is another important case on a very important matter – whose terms and conditions prevail when both parties present their own standard contracts and reject each other’s?

GHSP produced components for cars, and AB produced sensors which could be used in those components. GHSP invited a tender from AB, and AB responded saying that its terms and conditions would apply: they contained limits and exclusions of its liability. GHSP replied and said that its terms of purchase would apply: they contained no limits or exclusions of AB’s liability.

Matters drifted for some months, until things became urgent. AB said that it wanted a cap on its liability, but never pressed for its terms and conditions to apply. GHSP pressed for final technical specifications, and emailed AB to confirm that it could comply with the timescales, which AB did. AB at that point sent a copy of its acknowledgement of order containing its terms and conditions.

In fact, AB’s components were defective, causing GHSP’s components in turn to be defective; Ford, which had used the components in its cars, was forced to do an expensive and troublesome recall on its cars fitted with these components.

The judge found that each party had rejected the other’s terms and conditions, so neither set of terms and conditions applied to the contract. The contract was to be found in GHSP’s request for confirmation that AB could comply with the specifications and timescale, and AB’s confirmation that it could do so. AB’s acknowledgement of order was too late to have any effect – the contract was also made.

From AB’s point of view as the supplier, this was the worst of all possible worlds – it found itself in a contract, but without the benefit of the limits and exclusions of liability contained in its terms and conditions.

GHSP v AB Electronics – the Learning Points

AB’s mistake here was to let the contractual points slip to the bottom of the agenda. It was too reticent in raising the question of its terms and conditions with GHSP and lost the chance to incorporate them. While it had tried to negotiate a cap on its liability, it had not forced the issue and left it too late when it sent off its acknowledgement of order containing its terms and conditions.

Again, this case shows that the courts are prepared to find a contract in an exchange of emails, even though there are no terms and conditions applying to the transaction: the detail of the transaction was to be found in the technical specifications and the commercial discussions which resulted in agreement on the essentials of the deal, such as timescales.

Both parties could have tried to use “Subject to Contract”, but the closer you are to a finalised deal, the less likely a court will be to rely on such formal words, and the more you will have to use other ways to express the point, so as to demonstrate that you positively did not intend to enter into contractual relations until such points as liabilities had been agreed on.

Terms and conditions are part of a deal, and it is very important to set out such things as liabilities – less interesting perhaps than technical specifications, certainly less valuable than getting cash in for an ongoing project, but essential nonetheless for protecting your business.

Reasonable endeavours and good faith: can you rely on them?

CPC Group v Qatari Diar(5)

This case looked at the meaning of reasonable endeavours, a very important subject, as use of this and similar expressions has become so common: you should take a look at CPC Group v Qatari Diar.

 Gold Group v BDW Trading(6)

This case looked at the meaning of good faith. Along with reasonable or best endeavours (and various other similar formulations), we are beginning to see increased use of the expression “good faith”, which in turn means that the courts are starting to look at what it means. What does it mean, and more importantly, does it mean you have to sacrifice your own commercial interests in favour of the other contracting party?

BDW was contracted to develop property for Gold, and the contract provided that each party would at all times act in good faith towards the other and use all reasonable endeavours to ensure the observance by it of the agreement but “neither will seek to increase its profit or reduce its loss at the expense of the other.”

The recession bit, and BDW failed to continue with the works. One of its arguments was that Gold should re-negotiate the agreement so as, in effect, to change the contract to one more profitable from BDW’s point of view.

The court disagreed: the express provisions of the contract provided that neither party could seek to increase its profit or reduce its loss at the expense of the other, and the use of “good faith” did not mean of itself that a party should be required to give up a freely negotiated advantage under the agreement. In other words, a party would be held to its bargain – even if it turned out to be a loss-making one. “Good faith” meant that the parties had to deal with each other honestly and fairly, but in this case meant little more.

Gold Group v BDW Trading – the Learning Points

There is little case-law in this country about what “good faith” actually means in practice. We are beginning to see some case-law on the meaning of “reasonable endeavours”, but this is a developing area. Some care should be used when using this expression – in this case, the court declined to change the bargain between the parties, but this is an area of the law where things are developing, so some caution should be used when using this expression, and caution should also be used when dealing with another party where there is an obligation of good faith.

Limits and exclusions of liability

As usual, there have been a number of cases looking at this all-important area, and there are lessons which need to be learnt. If you are not a lawyer, you might also like to look at the 10 Minute Guide to Limits and Exclusions of Liability, which gives a brief introduction to this complex area of the law.

Markerstudy v Endsleigh(7)

This case looked at the vexed question of how to draft exclusions of consequential and indirect loss and what happens about loss of profits. There were various contracts between the parties. One provided:

“Neither party shall be liable to the other for any indirect or consequential loss (including but not limited to loss of goodwill, loss of business, loss of anticipated profits or savings and all other pure economic loss) arising out of or in connection with this Agreement."

Did this exclude loss of profits, even if those losses were direct? The court said no: the way the contract was drafted made it clear that the words in brackets were examples of indirect or consequential loss. Therefore, if there was a direct loss of profits, it was not excluded by these words. These words only excluded indirect or consequential loss.

Another contract provided:

“Endsleigh will not be liable to Markerstudy for any indirect or consequential loss or loss of profit or loss of business arising out of data input errors by Endsleigh put into Policy Schedules, Certificates of Insurance or Endorsements.”

Again, if there was a loss of profits which was direct loss, would these words be enough to exclude it? Again, the court said no: putting a list of expressions together meant that the later expressions were governed by the earlier expressions. The result was that only indirect loss of profits would be excluded – a direct loss of profits was not excluded by these words.

Learning Point: it is clear law that the expression “indirect” or “consequential” loss does not of itself include a loss of profits. It is amazing how many contracts still proceed on the basis that these expressions mean “loss of profits”: they do not. If you wish to exclude direct loss of profits (and other similar losses, like failure to make anticipated savings) then you must say so explicitly in the contract. This case shows that it is best to separate the two exclusions – so have one clause excluding indirect or consequential loss and another clause excluding loss of profits, making it clear that the latter applies whether the loss is direct or indirect.

GB Gas v Accenture(8)

This case looked at the types of loss and decided which were direct or indirect losses. This was a major project to provide a new billing system for GB Gas. GB Gas claimed for various losses, but the contract was better drafted this time, and provided that neither party would be liable for loss of profits or of contracts arising directly or indirectly or loss of business or of revenues arising directly or indirectly. This contract did not make the same mistake as the one above, and expressly provided that these types of losses were excluded whether they were direct or indirect.

GB Gas made various claims, including ex gratia sums paid to its disgruntled customers, the cost of additional borrowing because it could not get the right bills out on time, the cost of chasing debts not in fact due and the costs associated with setting up a special team to deal with the problems caused by issuing the wrong bills. Accenture argued that all these were indirect loss – but the trial judge and the Court of Appeal disagreed: they were all direct losses, even the ex gratia payments.

The Learning Points: this case is a good example of what items are in fact direct losses, when many people might have thought them to be indirect losses. Relying on a clause which excludes indirect or consequential loss is therefore less valuable than you might have thought. When considering exclusions or limitations, it is best to be specific about what exactly is excluded or limited.

Termination – the end game

The recession has thrown up a number of cases to do with escaping from your bargain.

Tandrin Aviation Holdings v Aero Toy Store(9)

This case concerned the purchase of a luxury jet. With the recession, the purchaser pulled out, and relied on the force majeure clause, arguing that the world recession was a reason for a release from the obligation to go through with the deal. The court disagreed: there is no general concept of force majeure in English Law, you have to look at the precise words of the force majeure clause. In this case, there was no reason to release the purchaser from the bargain.

The contract may provide for termination for material breach, but even so, the general law provides a party with a right to bring a contract to an end if the other party has “repudiated” the contract, or as it is often put, the other party is in “repudiatory breach”.

De Beers v Atos Origin(2)

This case was considered above but it also looked at the area of termination and when you can accept the other side’s breach as so serious that it justifies termination. The judge in this case took advantage of the decision of the Court of Appeal in Eminence Property Developments v Heaney(10) which has simplified the law in this area by making each case a specific factual enquiry rather than an extensive legal analysis of what had become a burgeoning number of cases on the subject.

In De Beers, therefore, the judge examined the facts and there are a number of learning points coming out of it. Atos Origin had threatened De Beers that it would suspend work if De Beers did not re-negotiate the contract with it and pay considerably more for the project to be completed. There was a provision in the contract entitling Atos Origin to suspend work for non-payment, and De Beers of course had failed to pay the fourth invoice. However, there was no power to suspend work in general, and certainly no entitlement in the contract to walk off site until a radically new payment structure had been agreed. The judge found that Atos Origin’s behaviour was, in the language of the law, “repudiatory” – it had evinced an intention no longer to be bound by the terms of the contract. This in turn entitled De Beers to “accept” that breach as bring the contract to an end, which it had done.

When looking at De Beers’ behaviour, the judge did not think that it had “repudiated” the contract. Non-payment was not as such repudiatory, and in this the judge came to same conclusion as another case in 2010 - Dominion Corporate Trustees v Debenhams(11). The learning point here is that, if you want to make non-payment a breach justifying immediate termination, you need to say so, using some such expression as making time of payment “of the essence” or spelling out that late payment would justify immediate termination. In fact, including a provision giving Atos Origin interest for late payment inclined the judge to think that this was an adequate remedy for late payment and that the parties could not have intended late payment to carry with it the drastic consequence of instant termination.

The judge in De Beers also thought that De Beers’ simply having a different view of how to operate the change control provision was not repudiatory – it was not evincing an intention no longer to be bound, it was simply having a different view of what the contract meant. Again, the judge came to same conclusion as the Court of Appeal in Eminence Property Developments v Heaney(10), where one party gave 7 calendar days’ notice instead of the contractual 7 working days’ notice. The Court of Appeal said that this admitted mistake did not show that it was seeking to avoid the contract, but was on the contrary mistakenly seeking to comply with the contract.

Force India Formula One Team v Etihad Airways(12)

This case looked at a perennially  difficult area in the law of terminating a contract for the other party’s repudiatory breach: how long can you wait until you decide to accept the other side’s breach as repudiatory?

Force India had a sponsorship agreement with Etihad, but decided to seek sponsorship elsewhere and simply started to work with another organisation. Etihad only discovered this by accident and only realised the full extent of the breach in November 2007. They called a meeting with Force India in mid-December, and Force India made some commercial proposals in mid-January 2008, but it took until the end of January 2008 before they terminated for Force India’s repudiatory breach.

The problem is that waiting to accept the other side’s breach as repudiatory can mean that you have “affirmed” the contract, and can no longer terminate. Was 3 months too long to wait in this case?

The Court of Appeal thought not, but said that every case will be different. International commodity sales will in general have a very short time in which they can be terminated for repudiatory breach – international trade depends on rapid decision-making. However, in this case, it happened over Christmas and New Year, when there was no racing anyway, Etihad had needed time to establish the full facts and there was no prejudice to Force India. Accordingly, Etihad had not “affirmed” the contract by waiting, and was entitled to terminate.

The learning points here are very important. All too often, people assume that, if there has been some sort of breach, that breach of itself gives them the right to terminate, and take as long about it as they choose. The contract may of course provide specific rights to terminate for material breach, and those provisions must be followed carefully. If you are relying on repudiatory breach, you are playing for high stakes – if you get it wrong, then your attempt to terminate the contract for the other side’s repudiatory breach could backfire on you, as giving notice wrongly or too late could itself be a repudiatory breach.

In any breach situation, you therefore need to be absolutely sure of your ground, ensuring that the other party actually is in repudiatory breach or in material breach if you are relying on such a clause in the contract. This calls for an extensive review of what has happened. There could be all sorts of reasons for the behaviour you think is a breach – and some of those reasons could mean that it is not in fact a breach at all.

The other point is that this extensive review must take place fast – three months was nearly too long in the Force India case, and in most cases, it is a question of days or weeks, not weeks or months. In international commodity contracts, it is more like hours or perhaps a few days, not even weeks. You could try reserving your rights, but the law could still ignore this, and hold that too long a delay amounts to an “affirmation” of the contract, preventing you from relying on the other party’s repudiatory breach.

Notes

 (1) Copyright Richard Stephens 2011. The law is stated as at 12 February 2011.

This note is intended to provide general information about legal developments in England & Wales and you should not apply any of the advice or information contained in it to specific situations without seeking professional advice first.

(2) [2010] EWHC 3276 (TCC)

(3) [2010] UKSC 14

(4) [2010] EWHC 1828 (Comm)

(5) [2010] EWHC 1535 (Ch)

(6) [2010] EWHC 1632 (TCC)

(7) [2010] EWCH 281 (Comm)

(8) [2010] EWCA Civ 912

(9) [2010] EWHC 40 (Comm)

(10) [2010] EWCA Civ 1168

(11) [2010] EWHC 1193

(12) [2010] EWCA Civ 1051