Limits on Contractual Limits on Liability — Part 2

In my last column I discussed the recent SCC guidance on the important exceptions that may come into play to reduce the effectiveness of contractual limitation of liability ("LOL") clauses. The SCC guidance focuses on different aspects of the LOL clause itself, or the behavior of the wrongdoer under the Agreement. These exceptions are important in the context of LOL clauses in technology-related supply agreements; but they are also relevant to any other type of commercial contract that contains an LOL clause.

In addition to these exceptions to the LOL clause, counterparties to agreements (and especially those parties who will be performing the lion’s share of obligations under it, typically by providing the other party with certain products or services) need to understand the parameters of a further way in which the effectiveness of LOL clauses may be undermined: namely, the spectre of the "pre-contractual warranty" claim.

Pre-Contractual Warranties

An important case that illustrates graphically the danger to suppliers of the pre-contractual warranty claim is the recently released decision in the BSkyB/EDS case. This UK-based litigation involved some of the biggest claims ever brought for a "computer project gone bad", and its impact on selling and contracting in the computer industry may be significant indeed (though presumably suppliers of goods and services in other industries will pay close attention to the decision as well).

In the BSkyB case, EDS was to implement a CRM (customer relationship management) system for BSkyB (a distributor of satellite-based home entertainment signals to subscribers throughout the UK). The CRM was a critical system for BSkyB, as it included billing, service provisioning, and many other indispensible features.

Very quickly after the contract was signed, and work began, it became clear that EDS had grossly underestimated the time it would take to complete the project. To make a very long story (there were 110 days of court proceedings, and the decision is about 450 pages long) very short, the court found that had EDS not been deceitful in presenting relatively short delivery timelines to BSkyB, BSkyB would have gone with the solution offered by another bidder.

In effect, the court found that EDS had perpetrated a fraud on BSkyB, and therefore the damages that BSkyB could recover from EDS were not limited by the various LOL provisions of the contract. The result is that on a contract with a £47 million revenue stream, and a £30 million LOL cap, the court has awarded partial interim damages of £270 million. Kind of takes your breath away.

While the BSkyB case is not referenced in the Tercon SCC case discussed in last month’s column, it is arguable that the scenario contemplated by the BSkyB case would come within the public policy exemption to enforceability of LOL clauses under the Tercon case. That is, the court in Tercon would likely not allow the enforcement of the LOL in the BSkyB case (if it were decided in Canada), because in doing so the perpetrator of an intentional misrepresentation would be allowed to find refuge behind the LOL clause.

Bad Witnesses Undermine Cases

As an aside, it is worth noting that the judge in the BSkyB case found EDS’ lead witness to be a teller of untruths. For example, BSkyB’s lawyers confronted the key witness by pointing out that the witness had received his purported MBA degree from a "fictional online university"; but the witness kept testifying as to attending business school classes in person. The BSkyB lawyer, however, drove home his point when he showed the court that he had registered his dog to receive the same online MBA degree, and the canine was successful in receiving it! In a word, the credibility of the key witness for EDS was destroyed, and this influenced the court on the crucial question of how this individual’s pre-contractual statements to BSkyB should be characterized from a legal perspective.

The impact of this devastating witness testimony reminds one of a similar situation in a leading Canadian copyright software infringement case, where the key witness for the defendant stated on the record in discoveries that he had no access to plaintiff’s source code (the crown jewels of plaintiff’s software program). If this were true, the plaintiff’s case would essentially evaporate, as independent creation is a full defence to a copyright claim. However, between the time of the discovery assertion of no access, and trial, the plaintiff forensically reconstructed the computer of this witness, and bingo, found a copy of the plaintiff’s source code on it. From that point on, the outcome of the case (in favour of plaintiff) was not in doubt.

The upshot of the deceitful behaviour by the key protagonist in this copyright case, is that the court made him jointly and severally liable for the infringement that was found to have occurred (in essence, the corporate vehicle used by the defendant did not shield him from personal liability). Thus, as with the finding in the BSkyB case, egregious activity on the part of individuals will often lead judges to deny defendants legal shelters, whether they are corporate structures or LOL clauses.

It’s 2010: Do You Know Where Your Damages Are?

Even where an LOL clause is upheld, its protection may not extend as far as the Supplier originally contemplated, given the uncertain interpretations given to the term "direct" and "indirect" damages. Consider another recent UK decision, where a computer services supplier failed to implement for a gas distribution company a new customer billing system. This billing system was critical to the very functioning of the customer’s utility company. So when it didn’t work properly, the customer quickly racked up large damages. The key question, however, is which of these damages are recoverable, when the relevant contract provides that lost profits, or loss of business revenues, whether arising directly or indirectly, are not recoverable by customer from supplier (even if supplier is otherwise liable under the Agreement).

Interestingly, the court in this case concluded that: gas distribution charges (of £18.7 million), compensation paid to customers (of £8 million), additional borrowing charges (of £2 million), the cost of chasing debt (of £387,287) and the cost of additional stationery (of £107,120), were all recoverable, and would be direct damages within the first limb of the rule in the seminal common law case on damages, Hadley v. Baxendale. One presumes that the supplier was quite surprised by this result.

Implications of these Decisions

It will be interesting to follow the adjustments in procurement practices for tech-related products and services, and in resulting contract language, brought about by these two cases as well as the Tercon decision discussed in the previous column. These could include the following:

  • suppliers will be much more cautious about the pre-contractual sales process, and may be much stricter on what sales people say (especially in writing);
  • customers and suppliers will try to break larger, single phase projects, into multiple smaller, independent projects. Each phase of work will then be accompanied by its own contract, including performance and payment milestones, so that reasonable expectations are much more closely aligned between the parties, though customers will resist this approach;
  • customers and suppliers will research more carefully what types of insurance are available for different sorts of risk; there will be greater emphasis on ensuring that, as between customer and supplier, responsibility for insurance rests primarily with the "least cost avoider";
  • in the LOL clause, more attention will be spent on enumerating which damages (by type) are recoverable (in favour of customer) and which are not (though suppliers resist this approach).