Exclusion clause for losses caused by IT company in its standard terms proves unreasonable

11/05/2010

An IT company which specialised in providing front and back office booking systems failed to provide an inner London 4 star hotel with a product which was fit for purpose.

The IT company (Red Star) relied on its standard terms and conditions to defeat a claim for damages for approximately £250,000, comprising the following:

a. Lost profits and loss of goodwill
b. Cost of a replacement system
c. Additional staff costs
d. Wasted staff costs

The standard terms and conditions were summarised as follows:

1. Under clause 2 Red Sky was required to sell the equipment and licence the computer system, provide (if any) the operating documents and provide the services and maintenance and support cover.


2. Clause 10.1 excluded all terms as to performance, quality, fitness for purpose etc except as provided in clause 10.2.


3. Clause 10.2 contained an express warranty that "the programmes will in all material respects provide the facilities and functions set out in the Operating Documents.


4. Operating Documents were defined to include "any operating documents supplied by the defendant to the claimant."


5. Clause 10.4 provided that the sole remedy for breach of the warranty was the Maintenance and Support Cover.


6. Clause 10.7 provided that clause 10, together with clause 18 stated the entire liability of the defendant in respect of any fault or error in the IT system.


7. Clause 18 contained limitations and exclusions of liability including excluding liability for any indirect or consequential loss. The term expressly excluded loss of profits and similar losses.

Red Sky contended that clause 10.1 excluded all terms relating to performance, quality, fitness for purpose etc: "to the fullest extent permitted by law" such that the implied terms on which Kingsway relied were incompatible with the express terms of the contract.

Red Sky accepted that Section 3 of the Unfair Contract Terms Act 1977 (UCTA) applied but argued that the test of reasonableness was satisfied.

Section 11(1) of the UCTA provides:
"The term shall have been a reasonable one to be included having regard to the circumstances which were or ought reasonably to have been known to or in the contemplation of the parties when the contract was made."

Reference was then made to the Guidelines in Schedule 2.

Red Sky claimed the following:

1. That the parties were of equal bargaining power relative to each other. There were over thirty property management systems competing in this highly competitive market.


2. The customer received a significant inducement to agree to the terms in that a significant discount was given and concessions were made on payment terms despite the fact that the contract price was very modest.


3. There was a long course of dealing between the parties so that Kingsway ought to have become aware of the existence of and extent of the terms. Clause 18.3 contained a prominent warning.


4. This was not bespoke software but it was adapted to the special order of the customer in that it would be configured for the particular customer. [The system] was used by a wide range of customers and the consequences of a breach would differ widely depending on which customers were using the software.

Red Sky also relied on section 11(4) of the UCTA which provides that in considering whether or not a clause or clauses in a contract satisfy the requirement of reasonableness, regard shall be had to:

a. "the resources which he could expect to be available to him for the purpose of meeting liability, should it arise.

b. how far it was open to him to cover himself by insurance."

Lastly, Red Sky contended that clause 10.2 would exclude the warranty in Section 4 of The Supply of Goods and Services Act 1982 that the goods were of satisfactory quality.

Kingsway contended that these clauses did not apply since clause 10.2 only applied if there were Operating Documents and no such documents were supplied at the time when [its system] was installed.

Kingsway also contended that clause 10.2 was not inconsistent with implied terms as to fitness and quality and that these are Red Sky's terms and under the contra proferentem rule any doubt or ambiguity in meaning is to be construed against Red Sky.

Lastly, Kingsway contended that if clause 10.2 was construed in the manner contended for by Red Sky and the term did otherwise preclude the normal implied terms as to quality and fitness for purpose, it would be unreasonable within the meaning of section 11 of the UCTA because:

1. It would purport to exclude these criteria without substituting any other and would allow a seller to provide unsatisfactory software without any benefit to the purchaser.


2. The terms, other than price were not discussed and conferred no benefit on Kingsway.


3. The bargaining power of the parties was all one way-save for the question of price and payment terms. The contract was entirely under the control of Red Sky - it was a take it or leave it arrangement.


4. There is no evidence that Kingsway even knew of the existence of the terms of exclusion. Red Sky did not draw it to Kingsways' notice clearly or at all.


5. The goods were off the shelf and were not made specifically for or specifically adapted for Kingsway.


6. Red Sky were specialists in the supply of hotel PMS software.


7. By the date of the agreement, Red Sky had the knowledge of supplying its software to other hotels and were therefore in the best position to assess the likelihood of the existence of any defects and their likely consequences.


8. There was no evidence that one party was in a better position to insure against the risk of the consequences of defects in the software although, given the factors set out in 6 and 7 above, it was a reasonable inference that Red Sky would have been in a better position.

The Court concluded that the UCTA did apply and that the test of reasonableness was not satisfied, adopting Kingsway's' submissions set out above.

It held that:
"Red Sky's contract is predicated on the basis it was able to sell its software as off the shelf rather than customised software and that the manuals, together with the demonstrations of the software, would enable a customer to understand the strengths and the limitations of the software and thus to decide whether it would fulfil its needs. The representations in the manuals would be crucial in explaining to potential customers whether the system provided the level of sophistication and speed which they required.... Without the manuals being supplied before the contract was entered into, it was not possible for potential customers to understand this and to make up their minds whether or not the system would be suitable for their needs. There is no evidence that such documents were provided at the time when the contract was signed."

In summary, Mr Justice Toulmin then concluded:

1. Red Sky's' standard terms were predicated on the fact that a prospective customer would investigate [its system] and make up its own mind whether or not to purchase based on demonstrations and the Operating Documents which Red Sky had previously supplied. It did not apply to circumstances in which the customer relied on Red Sky's' advice in deciding to purchase [its system].


2. The exclusions in clause 10.2 only applied where the Operating Documents as defined in Clause 1.1.6 were supplied to the customer before the contract was signed. In this case such documents were not supplied by Red Sky to Kingsway. Therefore, Clause 10.2 and the exclusions derived there from did not apply.


3. In any event, for the reasons set out above, the UCTA Section 11 applies. The terms following which restricted liability were unreasonable to be included having regard to the circumstances which were or reasonably ought to have been known to Red Sky or Kingsway, or be in the contemplation of the parties when the contract was made.


4. Pursuant to S14 of the Sale of Goods Act 1979, a term is to be implied into the contract that Entirety would be fit for the purpose for which it was bought, namely that the system would increase revenue and occupancy levels and would allow quicker check-in and check-out, including accurately processing groups and making changes to group reservations while preserving the accuracy of the system. I am satisfied that [its system] was not fit for the purpose for which it was sold.


5. Pursuant to Section 4 of the Supply of Goods and Services Act 1982 a term is to be implied into the contract that the goods were of satisfactory quality. [Its system] did not meet the standard that a reasonable person would regard as satisfactory, taking into account any description of the goods, the price and all other circumstance so as to satisfy S4(2A )of the 1982 Act.


6. Kingsway was entitled, as they did, to reject [the system] which, as delivered, was not of satisfactory quality or fit for its purpose. They were entitled to do so after giving Red Sky every opportunity to improve [the system], so that it would become of satisfactory quality and fit for its purpose."

(Kingsway Hall Hotel Ltd. v Red Sky IT (Hounslow) Ltd. [2010] EWHC 965 (TCC) (06 May 2010))

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