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Watford v Sanderson: The requirement of reasonableness in system supply contracts and more generally.
Elizabeth Macdonald,
Reader in Law,
University of Wales, Aberystwyth.
(e-mail: ezm@aber.ac.uk)
© Copyright 2001 Elizabeth Macdonald.
First published Web Journal of Current Legal Issues in association with
Blackstone Press Ltd
Summary
The problem of computer systems which do not do what the customer wanted
is becoming familiar. This comment / note is concerned with a particular aspect
of the Court of Appeal’s significant decision on such a contract, and
such a problem, in Watford v Sanderson – the effectiveness of
an exemption clause subject to the requirement of reasonableness under the
Unfair Contract Terms Act 1977. In particular, it considers the scope for
an appellate court to look at that issue, the recognition that a characteristic
feature of such contract may impact upon the application of the reasonableness
test, and the significance of the Court’s broader comments on the application
of that test in the commercial context more generally.
Contents
- Introduction
The facts
The dispute
The requirement of reasonableness - outline
The scope for reconsidering reasonableness on appeal
Application of the requirement of reasonableness – recognising the risk in system supply contracts
Application of the requirement of reasonableness – commercial contracts generally
Conclusion
Introduction
The problem of computer systems which do not do what the acquirer wanted is
becoming a familiar
one.(1) As such
systems are generally supplied under standard form contracts containing
exemption clauses, the significant issue will often be the effectiveness of such
a clause under the Unfair Contract Terms Act 1977 (UCTA) and, in particular,
that Act’s test of reasonableness. This note is concerned with an
important recent decision of the Court of Appeal on that issue - Watford
Electronics Ltd v Sanderson CFL Ltd [2001] 1 All ER (Comm) 696. Once the
facts and the dispute in Watford have been set out the requirement of
reasonableness will be briefly outlined, and consideration will then be given to
particular aspects of its application in the instant case – the scope for
an appellate court to substitute its own views of the reasonableness of a
clause, the recognition of the relevance of a characteristic feature of software
/ system supply contracts in relation to the requirement of reasonableness and
the significance of the Court’s comments on the approach to the
application of the requirement of reasonableness in the commercial context more
generally.
The facts
Watford Electronics Ltd v Sanderson CFL Ltd [2001] 1 All ER (Comm) 696 was concerned with the sale of a computer system. The claimant purchasers,
or customers, (Watford) were themselves suppliers of computer products,
principally by mail order, and with particular expertise in the supply of
personal computers. They had found the need for a computer system to deal with
their mail order business and to perform accounting functions. They contracted
with Sanderson for standard software (‘Mailbrain’ and
‘Genasys’) which was to be modified to meet their needs. There were
three contractual documents which were seen as making up the contract – a
sales ‘contract’ for equipment, a software licence for the standard
software, and a software modification licence covering stated modifications. The
three documents basically contained Sanderson’s standard terms, but
Watford had successfully negotiated for a price reduction and some modification
of the terms (see below). In the end, the total paid by Watford was
£104,596. For our purposes, the significant term of the sales
‘contract’ (which was also reflected in the two licenses) was cl 7
– the exemptions clause. Clause 7(3) stated
“Neither
the Company nor the Customer shall be liable to the other for any claims for
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 connected with any
claim.”
Watford had sought to have the exemption clause amended but Sanderson would
only agree to an addendum to it under which Sanderson committed to ‘their
best endeavours in allocating appropriate resources to the project to minimise
any losses that may arise from the contract’.
The dispute
The dispute arose because the system did not perform as Watford had wanted.
Watford basically claimed that there had been misrepresentations as to its
capabilities, breach of implied terms reflecting those representations, and of
terms that the system would be merchantable and reasonably fit for the purposes
for which it was supplied, and also breach of a duty (as a party with expertise)
to use skill and care in recommending a system. There was a contractual claim
which totalled about £5.5m and an alternative claim under the
Misrepresentation Act 1967 (or for negligent misstatement) for about
£200,500. A number of matters were ordered to be tried as preliminary
issues and the judgment of the Court of Appeal with which this note is concerned
dealt with an appeal on one of them – whether or not cl 7.3 satisfied the
requirement of reasonableness under the Unfair Contract Terms Act 1977.
The requirement of reasonableness - outline
Under section 11(1) of the Unfair Contract Terms Act 1977, in order to
satisfy the ‘requirement of reasonableness’, the term must have been
a fair and reasonable one to have included in the contract having regard to all
the circumstances which were or ought reasonably have been known to, or in the
contemplation of the parties when the contract was made. In other words, the
‘time-frame’ against which the assessment is made is that of the
making of the contract and the actual breach is not relevant to the
reasonableness of an exemption clause, merely potential breaches within the
reasonable contemplation of the parties when they contracted. The burden of
proof lies on the person seeking to rely upon the clause to show that it is
reasonable (s11(5)). There are guidelines on reasonableness in schedule 2. They
are only relevant by 'legislative prescription' when the requirement of
reasonableness is applied by sections 6 or 7, but they are a list of factors
which the courts have recognised to be generally factually relevant to the
requirement of reasonableness, under whichever section it is applied (eg
Phillips Products Ltd v Hyland [1987] 2 All ER 620, p 628). There is also
further specific guidance as to the treatment of clauses which limit liability
in section 11(4). In relation to such clauses, regard is to be had to the
resources available to the person seeking to rely on the clause to meet
potential liability and how far it was open to that party to obtain insurance
cover. In general, the courts have indicated the relevance of considering the
insurance situation eg whether the exemption clause placed the risk of some
problem with performance on the person best able to insure and whether the
allocation of the need to insure was reflected in the contract
price.(2) The
application of the ‘requirement of reasonableness’ is basically a
weighing process, with the various factors indicating the reasonableness, or
otherwise, of the clause, being put in the scales with an appropriate weighting.
(On the requirement of reasonableness generally see Macdonald, 1999a)
The scope for reconsidering reasonableness on appeal
It has been made plain that not every decision on reasonableness with which
an appellate court does not concur will be one which it will overturn. The
scope of this restricted approach to appeals deserves some consideration in the
light of Watford v Sanderson.
The restrictive approach to the appellate courts’ powers in relation
to a decision on the ‘requirement of reasonableness’ stems from
George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd [1983] 2 AC
803. There the House of Lords set out the basic approach to be taken by an
appellate court faced with a challenge as to the first instance view of the
reasonableness of an exemption clause under UCTA. Lord Bridge said (at pages
815-816):
"It would not be
accurate to describe such a decision as an exercise of discretion. But a
decision under [UCTA] ... will have this in common with the exercise of a
discretion, that, in having regard to the various matters to which ... section
11 of the Act of 1977 [directs] attention, the court must entertain a whole
range of considerations, put them in the scales on one side or the other, and
decide at the end of the day on which side the balance comes down. There will
sometimes be room for a legitimate difference of judicial opinion as to what the
answer should be, where it will be impossible to say that one view is
demonstrably wrong and the other demonstrably right. It must follow, in my view,
that, when asked to review such a decision on appeal, the appellate court should
treat the original decisions with the utmost respect and refrain from
interference with it unless satisfied that it proceeded upon some erroneous
principle or was plainly and obviously wrong"
This was quoted by Chadwick LJ in Watford v Sanderson (para 30) but
the court found no difficulty in regarding itself as able to take a different
view on reasonableness from the judge at first instance and they had several
points to justify that. The fact that the Court of Appeal differed from the view
taken at first instance as to the construction of the exemption clause plainly
gave them scope to do so, for
example.(3) It
is self evident that the coverage of an exemption clause is highly significant
in the determination of its reasonableness under UCTA.
However, not all of those points require consideration here. What does
deserve further consideration is the justification for intervention which the
court found in the failure of the judge at first instance to regard a particular
fact as relevant to the reasonableness test. At first instance, the fact that
the acquirers themselves used a similar exemption clause when they acted as
suppliers was not viewed as relevant. The Court of Appeal viewed that as a very
relevant factor and its use as such will be returned to below. The point to be
made here is that this has been seen as “straying quite close to what Lord
Bridge in the George Mitchell case called a ‘legitimate difference
of opinion’” (Barker 2001, 348). However, a distinction can be drawn
between the situation where an appellate court would differ from a judge at
first instance as to the weight to be given to a particular factor in carrying
out the weighing process which is required to determine reasonableness under
UCTA and the situation in which the courts disagree as to the need to place a
particular factor in the scales at all. If the former is not viewed as
sufficient to take a case into the area in which Lord Bridge viewed it as
appropriate for an appellate court to interfere, the latter can be explained as
a different level of disagreement. In fact it may also be seen as desirable that
the appellate courts should not feel themselves too constrained by Lord
Bridge’s dictum. Professor Goode has commented on the difficulties created
for the commercial community in the uncertainty generated by the use of
‘standards’ in the law rather than more certain rules (Goode, 1998,
pp 16-17). However, he also made the point that the uncertainty in the initial
use of standards may be lessened over time, when decisions have been made as to
their content. He said (p 17)
“The
distinction between standards and rules does not, of course, remain clear cut,
for the courts ... establish criteria by which standards are to be measured, in
order to promote consistency in decision making so that over time a standard
tends to assume characteristics of a rule”.
Nearly all of the litigation in which UCTA is relevant is commercial. There
may be a good reason not to treat Lord Bridge’s dictum too
widely.
Application of the requirement of reasonableness – recognising the risk in system supply contracts
The Court of Appeal’s finding of the reasonableness of the exemption
clause in Watford v Sanderson has been seen to be of great significance
by those concerned in the drafting and negotiating of system supply contracts
(eg Barker, 2001; Singleton, 2001, Harvey & Rudgard, 2001). All the more so
when it is viewed against the background of the finding of the unreasonableness
of the exemption clauses at first instance in other recent cases concerned with
system supply contracts (South West Water v ICL [1999] BLR 420, Pegler
v Wang (2000) 70 Con LR 68 and Horace Holman Group Ltd v Sherwood
International Group Ltd (2000) Unrep, 12th April). Certainly, it
is noteworthy in that context for the Court of Appeal’s recognition of one
of the characteristics of a contract involving the supply of bespoke or
customised software and of its relevance to the requirement of reasonableness.
The more software which has to be written in relation to the supply of a
particular computer system, the greater the difficulty involved for the supplier
in meeting the expectations of the customer. Firstly, there is the inherent
difficulty of those involved in a particular business of communicating to the
supplier everything which they require of the system – the customers knows
their business and the supplier knows about computer systems and there is often
an information gap. Secondly, it should be emphasised that there are great
problems in discovering bugs in software. So much so that the point has been
explained by analogy with chaos theory. It has been said (Lloyd and Simpson
(1994) at 79-80)
"It is impossible
to test even the simplest program in an exhaustive fashion. This is because of
the myriad possibilities for interaction (whether desired or not) between the
various elements of the program ... [Chaos theory] suggests that every event
influences every other event; that the beating of a butterfly’s wings has
an impact upon the development of a hurricane ... The theory’s hypothesis
is reality in a software context. Although software can and should be tested, it
has to be accepted that every piece of software will contain errors which may
not materialise until a particular and perhaps unrepeatable set of circumstances
occurs.”
In the light of such difficulties, the point should be made that in
Smith v. Bush Lord Griffiths indicated that a high degree of risk
in the contractual performance might indicate the reasonableness of an exemption
clause. It can be contended that elsewhere the courts have not taken sufficient
note of this in the context of system supply contracts (Macdonald, 1999b).
However, it should be emphasised that the point was clearly recognised in
Watford v Sanderson. There Court of Appeal recognised the
“significant risk that a non-standard software product,
‘customised’ to meet the particular ... needs of a ... relatively
complex business ... may not perform to the customer’s
satisfaction”. Such recognition is obviously significant if the
requirement of reasonableness is to be appropriately applied to contracts for
the supply of computer systems or just software.
Application of the requirement of reasonableness – commercial contracts generally
However, the case may be seen to have a much broader significance in the
commercial world more generally (Barker, 2001, p 348). Chadwick LJ may be seen
as signalling a restrained approach to the use of the requirement of
reasonableness in commercial contexts. He said in relation to the supply of a
product (para 54)
“In
circumstances in which parties of equal bargaining power negotiate a price for
the supply of a product under an agreement which provides for the person on whom
the risk of loss will fall, it seems to me that the court should be very
cautious before reaching the conclusion that the agreement which they have
reached is not a fair and reasonable one.”
And more broadly, in relation to commercial contracts generally (para
55)
“Where
experienced businessmen representing substantial companies of equal bargaining
power negotiate an agreement, they may be taken to have had regard to the
matters known to them. They should, in my view be taken to be the best judge of
the commercial fairness of the agreement which they have made; including the
fairness of each of the terms in that agreement. They should be taken to be the
best judge on the question whether the terms of the agreement are reasonable.
The court should not assume that either is likely to commit his company to an
agreement which he thinks is unfair, or which he thinks includes unreasonable
terms. Unless satisfied that one party has, in effect, taken unfair advantage of
the other – or that a term is so unreasonable that it cannot properly have
been understood or considered - the court should not interfere.”
Further consideration must be given to the significance of these comments
(and that to similar effect of Peter Gibson LJ at para 63).
The point must be made is that, in one sense, there is nothing new here. In
Photo Productions Ltd v Securicor Transport Ltd [1980] AC 827, Lord
Wilberforce said (p 843)
“In
commercial matters generally, when the parties are not of unequal bargaining
power, and when risks are normally borne by insurance, not only is the case for
judicial intervention undemonstrated, but there is everything to be said for
leaving the parties free to apportion the risks as they think fit and respecting
their decisions.”
Although couched in somewhat different terms the basic tenor of this
comment can be seen as having much in common with that of Chadwick LJ in
Watford v Sanderson. What must be emphasised is that, although
cited,(4) this
dictum cannot be regarded as having produced a generally non-interventionist
approach to the application of the requirement of reasonableness in the
commercial context. It cannot easily be predicted that the above dictum of
Chadwick LJ will have any greater impact.
In addition, the further point to be made in relation to the above dictum
of Chadwick LJ is that it has been emphasised that each case on the requirement
of reasonableness is dependent upon its own
facts.(5)
‘It may be fair and reasonable to disclaim against X when it would not be
fair and reasonable to disclaim against Y’ (Stevenson v Nationwide
Building Soc [1984] EGD 934). That militates against the adoption of any
general approach to the reasonableness test which takes a non-interventionist
approach to commercial contracts generally (Brownsword, 2000, p60). In
addition, it must not be forgotten that the burden of proof lies upon the party
seeking to rely upon the clause (s11(5)) and, even if Chadwick LJ’s dictum
is widely cited and seen as an approach which should be carried into effect,
each case will still be dependent upon its own particular facts even if there is
a non-interventionist impetus. Two further points must be made in this context.
First, the particular facts of Watford v Sanderson indicate very strongly
the presence of those factors which Chadwick LJ identified as showing that the
courts should leave the bargain as it was made by the parties. Secondly, there
may well be particular facts in specific cases which clearly indicate the case
to be one in which the court should intervene. Both of these point should be
explained further.
In Watford v Sanderson the Court of Appeal clearly identified strong
factors against intervention in the contract as made by the parties. The parties
were regarded as of equal bargaining power (although there was no other package
available on the market which appeared to meet Watford’s needs and system
supply contracts generally came with exemption clauses). As has been indicated,
it was recognised that the provision of a computer system was one in which there
was a ‘significant risk’ that the system would not perform to the
customer’s satisfaction, thereby losing the customer profits or efficiency
savings. It was also recognised that the risks should have been contemplated by
both parties when they made the contract, that the loss was likely to be capable
of being covered by insurance (at a cost), and that both of them should have
contemplated that the contract price would be affected by who was to bear the
risk of that loss. In the instant case, there were seen to be strong indicators
that loss should be left where the exemption clause allocated it as the parties
had negotiated on the contract price, which had been reduced, and the customer
had managed to secure some increase in the undertakings of the supplier (ie as
to the use of best endeavours to secure the use of appropriate resources to
ensure the system worked correctly). In addition, the customer, Watford’s,
understanding of the relationship between the contract price and the allocation
of risk (or the need to insure against it) was regarded as made plain by
Watford’s own standard terms, which it used when itself supplying items,
and which contained an exemption clause which even went so far as to explicitly
state that relationship. The facts in Watford can be seen as strongly
corresponding to the circumstances which Chadwick LJ identified as showing that
the parties “should ... be taken to be the best judge of the commercial
fairness of the agreement which they have made; including the fairness of each
of the terms in that agreement.”
In contrast, as has been indicated, the point can also be made that the
particular facts of a case may show the need for the courts to intervene by
finding an exemption clause unreasonable. So, for example, in the context of
system, or software, supply contracts, St Albans City and District Council v
ICL Ltd [1996] 4 All ER 481 has been seen as part of the ‘high water
mark against limited liability’ (Harvey & Rudgard, 2001, p25), and
Pegler v Wang has been seen as part of ‘the high water mark of
judicial intervention in limitation provisions’ (Barker, 2000, p 348), but
there is a strong basis for contending that both would still be decided in the
same way even after the decision of the Court of Appeal in Watford v
Sanderson. In the St Alban’s case, the clause in question set
£100,000 as the limit of liability, but that limit had been used by
mistake. When the particular contract was made, ICL’s standard limit was
£125,00 and through ICL’s error a previous version of its standard
terms, with the lower limit had been used. Under such circumstances it would
certainly be difficult to argue that ICL had regarded the £100,000 limit as
a fair allocation of the contract risk. In Pegler v Wang, Wang had misled
Pegler as to the ‘fit’ between the standard software they could
supply and Pegler’s needs. As has been indicated, it is in trying to adapt
software to meet the customer’s needs that the risk in the supply and
purchase of computer systems arises. In Watford it had indicated the
reasonableness of the clause that both parties recognised the risk and the need
to allocate responsibility for it (or insurance against it) and the reflection
of that in the contract price. In Pegler v Wang, the misrepresentation of
the degree to which the standard software, as such, fitted Pegler’s needs
led to the conclusion that it “would be one thing for Wang to include in
their contract standard terms intended to exclude liability in the event of some
not readily foreseeable lapse on their part, but quite another to do so when
they had so misrepresented what they were selling that breaches of contract were
not unlikely”. Under such circumstances, there would be no reason to take
the Watford view that the court should not interfere with the terms of
the contract because the parties should “be taken to be the best judge of
the commercial fairness of the agreement which they have made”.
Conclusion
Watford v Sanderson is certainly a noteworthy appellate decision in
the area of system supply contracts. It is important for its recognition of a
significant characteristic of system supply contracts involving bespoke or
customised software – the risk that the system will not do what the
customer wanted. Its value as an indicator of the general attitude with which
the judges will approach the application of the requirement of reasonableness in
commercial contracts more generally is less clear.
Bibliography
Barker, D (2001) ‘A Return to Freedom of Contract’ 151 New
Law Journal 344.
Brownsword, R (2000) Contract Law: Themes for the Twenty-First
Century (London: Butterworths)
Goode, R (1998) Commercial Law in the Next Millenium (London: Sweet
& Maxwell).
Harvey, M & Rudgard, N (2001) ‘The Rebirth of Limited Liability
Clauses’ Computers & Law (April/May) 24
Lloyd, I and Simpson, M (1994) Law on the Electronic Frontier Hume
Papers on Public Policy, Vol 2, No 4, (Edinburgh; Edinburgh University
press).
Macdonald, E (1999a) Exemption Clauses and Unfair Terms (London:
Butterworths).
Macdonald, E (1999b) ‘Y2K and Contractual Exemption Clauses’
1999 (2) The Journal of Information, Law and Technology -
http://www.law.warwick.ac.uk/jilt/99-2/macdonald.html
Singleton, E.S (2001) ‘Watford Electronics v Sanderson –
Exclusion Clauses in IT Contracts’ 165 Justice of the Peace
346
(1) eg Mackenzie
Patten & Co v British Olivetti Ltd (1984) Unrep, 11th Jan,
Micron Computer Systems Ltd v Wang (UK) Ltd (1990) Unrep, 9th
May, Saphena Computing Ltd v Allied Collection Agencies Ltd [1995] FSR
616, St Alban’s City and District Council v ICL [1996] 4 All ER 481, Pegler Ltd v Wang (UK) Ltd (2000) 70 Con LR 68, Anglo Group plc
v Winther Brown & Co Ltd (2000) Unrep, 1st March.
(2) Photo
Production Ltd v Securicor Ltd [1980] AC 827, George Mitchell Ltd v
Finney Lock Seeds Ltd [1983] 2 AC 803, Smith v Eric S Bush [1989]
2 All ER 514.
(3) The Court
of Appeal disagreed with the judge at first instance as to the impact on the
construction of the exemption clause (cl 7(3)) of the presence in the contract
of an ‘entire agreement’ clause. In the light of the existence of
that second clause, the Court of Appeal found that the exemption clause did
not cover liability for misrepresentation, merely for breach.
(4) Eg Salvage
Assn v Cap Financial Sevices [1995] FSR 654, Chester Grosvenor Hotel
Ltd v Alfred McAlpine (1991) 56 Build LR 115, Fillite Runcorn v APV Pasilac
(1993) Unrep, 22nd April, Edwards Murray Ltd v BSP International
Foundations Ltd (1992) 33 Con LR 1, W Photoprint Ltd v Forward Trust
Group (1993) Tr LR 146.
(5) Phillips
Products Ltd v Hyland [1987] 2 All ER 620, p 628, Edmund Murray Ltd v
BSP International Foundation Ltd (1993) 33 Con LR 1, Sonicar International
v East Anglia Freight Terminal Ltd [1997] 2 Ll Rep 48 at 55.