Exclusion of liability for loss of profit
Soteria v IBM (Court of Appeal) [2022]
Ever since it was issued last spring, the original High Court judgment in this case, as to the effect of a loss of profit exclusion clause, has been highly controversial and much criticised. The overturning of that decision is to be welcomed not least because it accords more with normal use of language.
Facts:
The facts are as previously reported in our report of the original High Court judgment http://www.trglaw.com/news324.html
Soteria (previously Co-op General Insurance or ‘CIS’) appealed the finding that a ‘loss of profit’ exclusion prevented its claim in respect of wasted expenditure. This single issue had a very material financial impact of around £80million.
The original judge had decided that the loss of profit exclusion in clause 23.3 of the contract excluded in its entirety Soteria’s claim for wasted expenditure including fees paid to IBM. The items of wasted expenditure which, on the original High Court judge's ruling, clause 23.3 excluded, broadly consisted of items of expenditure (including £34.1 million paid to IBM and other large sums paid to third party suppliers) incurred by Soteria in the expectation that IBM would perform their contractual obligations and provide them with a much-improved IT system. There was also a significant claim for financing costs.
Decision:
The Court of Appeal emphasised that the starting point for any damages claim is the compensatory principle, namely that a party who suffers loss as a result of breach of contract is entitled to be placed in the same situation, with respect to damages, as if the contract had been performed.
It then went on to say that when a claimant claims damages in consequence of the other side's repudiation, there is a choice. The claimant can either claim its loss of profits or, alternatively, its wasted expenditure. If the claim is for wasted expenditure, it is not limited to the expenditure incurred after the contract was made but can also include the expenditure before the contract, provided it was reasonably in the contemplation of the parties as likely to be wasted if the contract was breached.
The Court of Appeal gave a number of separate reasons why the original judge was wrong to conclude that the loss of profit exclusion precluded Soteria from recovering its claims for wasted expenditure following IBM’s repudiation of the contract.
- The ‘natural and ordinary meaning of the words used’. As a matter of language, the description of the types of losses being excluded, were not apt to cover or include “wasted expenditure”. As the judge said, “In my view, the fundamental difficulty, which IBM never addressed, let alone surmounted, is that claims for “wasted expenditure” were not excluded by the terms of clause 23.3 because those words are simply not there”.
- 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 his catastrophic non-performance. There was nothing in clause 23.3 to suggest that the costs, which Soteria inevitably incurred in the expectation that [the contract] would be completed satisfactorily, would somehow be irrecoverable if IBM repudiated that contract. There were no relevant exclusionary words, let alone clear and obvious ones.
- Loss of profit claims are inevitably difficult for the potential contract-breaker [and, indeed, the counterparty] to estimate in advance. They can be notoriously open-ended. As the judge said, “Claims for loss of profit, revenue and savings are types of potential loss which, because of problems of speculation and ascertainment, are routinely excluded by clauses like clause 23.3”. On the other hand, claims for wasted expenditure are an entirely different animal. If the victim of a breach of contract has spent money in anticipation that the contract would be performed, then its loss is easy to ascertain: there will be invoices, contracts, receipts and the like. This type of loss is the opposite of speculative: it is precisely ascertainable. It is a pure accounting exercise. The claims that would have compensated Soteria 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 IT system were not. That struck a fair commercial balance as between the parties.
- The characterisation by the original High Court judge of “wasted expenditure” as a method of calculating “lost profits, revenues or savings” was said to involve “an unjustified leap of reasoning”. Whilst lost profits is one method of calculating damages for the loss of the 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.
Points to Note:
- Whichever side of the fence you are on, whether as a supplier or customer, this judgment by the Court of Appeal has to be warmly welcomed not simply because it provides clarity but also because it accords with common sense and the natural use of language.
- The judge did, however, make some comments during the course of the judgment which were unhelpful and, we would suggest, potentially inaccurate. In particular, the judge said “loss of profit, revenue, savings are all of a similar kind. They are often considered to be types of consequential loss”. The meaning and effect of a ‘consequential loss’ exclusion has long been debated. It seems to have been quite firmly established for some years that loss of profit very often qualifies as a direct (as opposed to consequential) loss. To again muddy the water is unhelpful. The judge also said “in my view, the other types of loss which were excluded by clause 23.3 (data, goodwill and reputation) are also species of loss of profit claims. It is difficult to see how a loss of data claim can sound in anything other than loss of profits or a decrease in revenue”. Quite how this statement can be justified is difficult to see. Clearly, loss of data can give rise to a broad range of losses both in terms of liabilities to data subjects, regulatory fines for breach of data protection laws and the costs of reconstituting data. None of these are, in our view, properly categorised as a loss of profit. We certainly wouldn’t recommend that any supplier or service provider should rely upon a loss of profit exclusion if it also wants to exclude liability for loss of data.
- There is some suggestion that IBM may be considering a further appeal to the Supreme Court, so this may not be the final word on the matter.
- We will report on other aspects of the Court of Appeal judgment in our next edition of the TRG Update.