Information and Communications Technology: Case Note - SAM Business Systems Limited v Hedley & Co.
 

Jane Lambert

27 Dec 2002
This case note first appeared on the NIPC website

As well as being of local interest to Northern practitioners in that the defendants were Lancashire stockbrokers represented by Rawsthorns, this judgment is noteworthy for 4 important points. The first is Judge Bowsher's assertion that if a software system is sold as tried and tested it should not have any bugs at all, and, if there are any, such bugs should be regarded as defects. The second is the balancing exercise
by which His Honour determined whether an "entire agreement" clause satisfies the requirement of reasonableness under the Unfair Contract Terms Act 1977 ("UCTA"). The third was a reminder that a customer may reject a computer system only if he gives timely and unequivocal notice and does so before he gains any substantial benefit from the system. The fourth and last point is the judge made it clear that a
supplier cannot charge a maintenance fee for correcting bugs in a tried and tested system that should not have been there in the first place.

The Dispute
This was a claim by a small systems house against a medium size firm of stockbrokers for £310,509.84 plus interest claimed in respect of licence fees and post-installation maintenance and other services for an applications software package. The stockbrokers, who had already paid £184,605.32 to their supplier, counterclaimed for their money back plus damages for the increased cost of working, write-offs, fines and
additional charges, mitigation costs, and loss of profits which amounted to £789,658.44 plus interest.

The Facts

This was in a sense a Y2K action. The software package that gave rise to the litigation had been ordered towards the end of 1999 because the defendants feared that their otherwise serviceable if old-fashioned DOS based transaction processing system would not function properly in the new millennium. The claimant's software was a ready-made package of software modules for stockbrokers and others dealing in stocks and shares. Its functions included processing and settling transactions in buying and selling shares, accounting for clients' money, and communicating with CREST. The brokers first approached the claimant in July 1999 who demonstrated its system to them in September. In its brochure6 and in subsequent correspondence as well as in pre-contract discussions, the supplier made various claims for the suitability and reliability of its product and promised a money back guarantee should the brokers be dissatisfied. Those representations and promise helped to persuade the brokers to acquire it. Licence and maintenance agreements were signed in October and the software was delivered in December 1999. Serious problems occurred almost immediately after installation. Some of those problems were fixed quite quickly but others arose throughout 2000. At least one of those problems brought the defendants into conflict with their regulator, the SFA. In January 2001, the defendants decided to stop using the system and to outsource their back office. They did not tell the supplier of their decision until early in February. Outsourcing commenced in May 2001. The claimant issued proceedings were issued in June 2001. The brokers counterclaimed for the damages mentioned above on the grounds of misrepresentations and breach of contract. They pleaded that they were entitled to rescind the contracts, alternatively, to reject the system or in the further alternative to treat the agreements as having been repudiated by the supplier.

The Contracts
The parties entered into 2 written agreements, namely a licence and a maintenance agreement, which were signed by the supplier on the 12 and by the brokers on the 18 Oct 1999 respectively.

The Licence

The licence required a licence fee of £116,000 to be paid at 3 stages:

	£58,000 on signature
	£29,000 on installation, and
	£29,000 on completion.

"Completion" was to have taken place 30 days after the supplier had informed the customer in writing that the software had been installed unless, within that 30 day period the customer, informed the supplier of instances where the software failed certain defined acceptance criteria. Delivery and installation were to take place within the later of 30 days after suitable computing environments have been made available to the supplier by the customer or 30 days from signature of this agreement. The agreement set out detailed machinery for the customer to make acceptance tests and, if not satisfied, to reject the software. The supplier, on the other hand, had the right to demand arbitration if not satisfied that rejection was justified. The licence also contained "entire agreement", exclusion and limitation of liability clauses. In addition to the express terms, the judge accepted the defendants' submission that the following implied terms had been imported into the licence agreement subject only to whether they could be negatived by the entire agreement clause:

"a) [the claimant's software] would be constructed and installed at [the defendants'] premises with all proper and professional care and skill;
b) [the software] would be reasonably fit for the purposes for which [the defendants] required it;
c) [the software] would be of satisfactory quality;
d) [the software] would properly and efficiently perform all the required functions;
e) [the software] would perform all such functions in such a way as to enable [the defendant firm] to fulfil its professional obligations to its clients and its statutory duties as required by the FSA;
f) [the claimant] would efficiently carry out the migration and processing of the [existing system's] data."

These submissions were based on s. 4 and s. 13 of the Supply of Goods and Services Act, 1982 and the judgment of Sir Ian Glidewell in St. Alban's DC v. International Computers Limited.

The Maintenance Agreement
By the maintenance agreement, the claimant undertook to provide:

	diagnosis and correction of reproducible software errors during normal office hours;
	telephone support of the application software to 2 named operators or their alternates during normal office hours;
	delivery by remote link of application software maintenance, releases and corrections as they become available for the application software;
	periodic documentation updates as they become available for the application software; and
	version control of the application software.

The agreement was to come into effect as soon as the licence had been executed. It was to remain in force for an initial term of 12 months (unless the licence was terminated by reason of the supplier's breach in which case the maintenance agreement would also come to an) and thereafter from year to year unless terminated upon 6 months notice by either party.

The Judgment

It was common ground that "completion" as defined by the licence agreement had never taken place. However, neither party had invoked the dispute resolution procedure. The judge dealt first with the counterclaim, which required him to decide whether the claimant could rely on the "whole agreement" clause to defeat the misrepresentation claim, and the limitation clauses to defeat the breach of contract claim. His Honour found that those clauses did satisfy the requirement of reasonableness and that they effectively excluded the claims for misrepresentation and breach of contract. As to the claim, the judge found that the defendants had made lengthy efforts over a year to co-operate with the supplier to get the package to work
and that they had acted perfectly reasonably at the end of that year in saying that they were not going to try any further to get the software to work but that did not give them the right to reject the package. Were such relief to be granted:

"[it] would mean that Hedley's get use of [the software] for 17 months for nothing and also get damages for defects in the system. That cannot be right. If [the defendants] had not had [the software] the firm would have been out of business.  The contract gave [the defendants] the opportunity to get their money back if they went through a specified process. If they had gone through that process they would not have had 17 months use of [the software]. They did not go through that process."

The judge found that the claimant was entitled to the payments due under the first and second stages of the licence agreement but not the third because completion had not occurred. He also found that it was entitled to some maintenance charges but not for the costs of putting right bugs in the software that should never have been there in the first place. As the defendants had already paid £183,893.27 under the licence and
maintenance agreements the only sum due to the claimant was a small balance of £8,773.73 in respect of maintenance plus interest of £1,077.89 charged at 8% over 12 months. His Honour made no order for costs.

Reasonableness of the Exceptions Clauses
The judge's starting point was that the defendants needed a Y2K compliant system and that could only get one on the claimant's terms. Other suppliers similar inserted exclusion and limitation clauses into their contracts. Such terms were necessary to enable suppliers to carry on business. In the judge's words:

"Although it has not been said in so many terms, [the supplier's] attitude seems to be, "We did not have to take on this contract. Having taken it on our terms, why should the contract be rewritten to expose us to a huge risk and possibly put us out of business?" That is a freedom of contract attitude that would have been entirely acceptable in the nineteenth and early twentieth centuries. Can it survive since Parliament intervened at the behest of the Law Commission in 1977?"

In His Honour's view it could. The supplier did not abdicate all responsibility as it offered customers 'a standard money back guarantee on licence' if they were dissatisfied with the package. The judge made it clear that he would have regarded the exclusion of liability and entire agreement clauses as quite unreasonable had there been no such guarantee though he would have regarded a limitation of liability to
the amount of money paid under the licence agreement as reasonable. But on the evidence before him and in all the circumstances to which he had referred (which would not necessarily exist with other contracts signed on the same terms) he found that all of the terms to which objection was taken in the contract were reasonable. The parties were of equal bargaining power in terms of their relative size and resources. The defendants were in a difficult position of their own making because of their lateness in tackling the problem of Y2K compliance. The evidence from the supplier was that other companies like theirs had similar exclusion clauses. The defendants did not even try to negotiate for terms more favourable to them.

Interrelation between Exceptions Clauses and Maintenance Agreements
As has been pointed out above, the judge expressed the view early in this judgment that software that is sold as tried and tested should not have any bugs at all but, if it does, such bugs should be regarded as defects. It followed that a supplier has a duty to put right such defects at his own expense even if he excludes or limits his liability by means of an exceptions clause:

"I cannot see that it is right that [the claimant] should be paid for putting right a defect in respect of which they have excluded liability to pay damages. Of course, any product, whether it be a motor car, or a washing machine, or computer software, may, after working well to start with, then develop faults and faults arising in that way, provided they did not exist in a hidden form on delivery, would be the proper subject of a maintenance agreement. But no consumer would or should accept liability to pay for rectification of defects existing in goods on delivery even if there was no contractual liability on the part of the supplier to pay damages arising out of those defects. If a company supplies to a factory a power unit that from the outset does not work, the supplier may be able to sustain a case that he cannot be sued because of his exclusion clauses, but he could not conceivably charge for making it work under a maintenance contract. 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."

Applying that rule the judge disallowed most of the claimant's charges for work done under the maintenance agreement.

Comment
There are 2 important lessons from this judgment. First, it showed that litigation in the Technology and Construction Court is not always the most cost-effective way of resolving computer supply disputes. Even though this case had been one of the least painful computer supply cases in that it came on for trial relatively quickly it still lasted for 12 days not counting the handing down of judgment. With silks, juniors and experts on both sides, the costs must have been horrendous. At the end of this very expensive process the claimant was awarded less than £10,000 in damages. This complex dispute boiled down to whether the supplier could rely on the contract terms to limit its liability and recover under the maintenance agreement the costs of correcting bugs in its software. These were essentially issues of law which could almost certainly have been resolved more economically by expert determination or, at the very worst, by their trial as preliminary issues. Although the Pre-Action Protocol for Construction and Engineering Disputes had been published long before this dispute began, and its relevance to computer supply disputes made clear in a number of articles one of which had been on chambers website since August 2000, nothing in the
judgment indicates that either party or their advisors referred to that protocol. Had they done so the above issues are likely to have been identified either in letters of claim or response or picked up at a pre-action meeting. Paragraph 5.4 of the Protocol would also have required the parties to consider in respect of each agreed issue and the dispute as a whole whether some form of alternative dispute resolution procedure
would be more suitable than litigation, and if so, to endeavour to agree which form to adopt. Even if they could not have agreed to resolve their dispute by ADR, they would still have been required to use their best endeavours to agree ways of saving costs.

The second important lesson from this litigation is that it is still possible for suppliers to limit or even liability for misrepresentation or breach of contract in a computer
supply contract by means of contract terms notwithstanding UCTA so long as the customer is allowed reasonable redress. In this case, the customer could have asked for his money back so long as he gave timely notice of rejection and did so before he had actually gained any benefit from the system. As the requirement to give timely notice of rejection before any benefit is gained will often conflict with the countervailing requirement to mitigate loss. Those acting for customers will have to be astute either to negotiate terms that preserve the right to reject until after the system has been given a fair trial wherever possible.

 

 

 

 

 

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