In a recent case concerning the failed implementation of an IT system, the Court of Appeal has provided important guidance on the interaction between exclusion clauses and contractual damages claims for wasted expenditure - Soteria Insurance Limited (formerly CIS General Insurance Limited) v IBM United Kingdom Limited.

It has overturned a first instance decision which threatened to open up a gap between commercial drafting practice for exclusion clauses and the principles applied by the courts for assessing damages. 

Soteria (formerly CIS General Insurance Limited) entered into a contract with IBM for the supply of a new IT system. IBM subsequently terminated the contract for purported non-payment of an invoice by Soteria.

Soteria disputed IBM's right to terminate and treated the purported termination as a repudiatory breach of contract, entitling it to claim damages for loss of bargain (usually calculated on either a loss of profit or wasted expenditure basis).

At “first instance”, Mrs Justice O’Farrell found in favour of Soteria and held that IBM had wrongfully terminated the contract.

However, IBM had the benefit of a strong exclusion clause which excluded all "loss of profit, revenue, savings (including anticipated savings) … (in all cases whether direct or indirect)".

Given this clear exclusion of loss of profit, Soteria framed its claim as wasted expenditure instead - effectively the sunk costs of £128m which it had wasted as a result of the project abandonment.

However somewhat controversially, Mrs Justice O’Farrell found this wasted expenditure claim was also excluded. In her analysis, Soteria had intended to benefit financially from the contract and so would have expected to have recouped its wasted expenditure through the revenue, savings and anticipated savings generated by the IT system. As these heads of loss were excluded, this meant that Soteria had also excluded its right to claim for wasted expenditure.

The effect of this decision was to leave Soteria with damages for just a fraction of its sunk costs and seriously out of pocket. Unsurprisingly, it chose to appeal the decision.

The primary issue for Court of Appeal was the proper construction of the exclusion clause. It overturned the first instance decision and held that the exclusion clause did not exclude claims for wasted expenditure. The key points from the Court of Appeal’s reasoning (Coulson LJ) are as follows:

• The exclusion clause specified the types of loss that were excluded - loss of profit, revenue, savings, data, goodwill and reputation. There was, however, no express reference to ‘wasted expenditure’.
• A reasonable person in the position of the parties, would not interpret the ordinary and natural meaning of the words “profit”, “revenue” and “savings”, as also excluding claims for wasted expenditure. In the light of the particularity in the exclusion clause as to the types of loss excluded, the parties' decision not to include express reference to claims for wasted expenditure was “telling”.
• The court’s approach to exclusion clauses (in line with the Gilbert Ash principle) should be that: “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”.
• The language in the contract did not even come close to such clarity - particularly given that the effect would be to prevent Soteria from claiming significant sums it had paid to IBM in reliance on the contract.
• The types of loss expressly referred to in the exclusion clause were types of consequential loss (loss of profit, revenue, savings) and species of loss of profit claims (data, goodwill, reputation) which are speculative in nature and which are routinely excluded for commercial reasons. In contrast, the court held that “claims for wasted expenditure are an entirely different animal” and ascertainable. Excluding loss of profit but not wasted expenditure strikes a fair balance between the parties.
• The Court of Appeal also focused on the statement of Steyn LJ in Surrey CC v Bredero that loss of bargain may compensate for either the positive interests of a party (their loss of profit) or negative interests (their expenses incurred). It interpreted the clause as applying to only Soteria’s positive interests, leaving open a claim for wasted expenditure.
• There might be practical judicial reasons for a rebuttable presumption that a party will recoup wasted expenditure out of the money it makes on a contract. That does not mean that wasted expenditure is a method of assessing loss of profit, savings or revenue. They are different types of claim. Furthermore, taking a different approach depending on whether the contract is for financial or non-financial benefits would produce incoherent results.

Overall, this reasoning probably brings the interpretation of exclusion clauses in the context of wasted expenditure more into line with commercial practice and intent. Going forward, the Court of Appeal’s judgment may prove influential in relation to exclusions clauses generally. The emphasis on the distinction between positive and negative interests in loss of bargain claims is interesting. Many standard exclusion clauses are mostly directed at consequential losses (i.e. positive interests). It may mean that the court will subject future attempts to exclude wasted expenditure through standard suite contractual wording to very close scrutiny. Parties wishing to exclude wasted expenditure claims should, therefore, use express clear words.