Contractual damages and exclusion clauses: you get what you bargained for (CIS v IBM)
Where a party terminates a contract for repudiatory breach, a damages award should place it in the position it would have been in had the contract been properly performed. Assuming the contract was a profitable one, there are two alternative measures of loss which might be sought: 1) “expectation loss” (the financial benefit which the non-defaulting party expected from the contract, e.g. increased profits or reduced expenditure); or 2) “reliance loss” (the wasted costs incurred in the expectation of the financial benefit, e.g. payments to the counterparty, third parties and internal costs).
In CIS General Insurance Ltd v IBM United Kingdom Ltd  EWHC 347 (TCC), O'Farrell J analysed the authorities on the two measures of contractual loss. She held that, although the two methods for quantifying loss of bargain are different, there is no change in the underlying characteristics of the losses for which compensation is sought. Here, this meant that a claim for reliance losses (or wasted expenditure) fell within an exclusion of liability clause which excluded claims for “loss of profit, revenue, savings… (in all cases whether direct or indirect)…” (the "Exclusion Clause"). The effect of this finding was to reduce the damages awarded from £128 million to £15.9 million. This judgment provides a stark reminder of the need to carefully consider the scope and application of exclusion clauses when contracting.
Following a reorganisation within the Co-operative Group Limited (the "Co-op Group"), in 2015, CIS General Insurance Limited ("CIS") (the former insurance business of the Co-op Group) contracted with IBM for a new IT system (the "System"). The cost of supply and implementation of the System was over £50 million and the cost of the management services to be provided by IBM over a 10-year period was estimated at £125.6 million. The implementation did not go well.
In 2017, CIS, disputed an invoice from IBM, which O'Farrell J determined it had done validly. Thereafter, IBM purported to terminate the contract by notice following CIS’ failure to pay the invoice, without adhering to the contractual escalation process. O'Farrell J accepted CIS’ claim that in wrongfully purporting to terminate the contract, IBM was in repudiatory breach, which breach CIS accepted1.
Conclusions on contractual exclusion clauses
CIS sought damages on the "reliance loss" basis rather than on the basis of "expectation loss" (i.e. the additional costs of obtaining the System (or a system of equivalent functionality) from another vendor). CIS’ primary claim was for wasted expenditure in the sum of £128 million. In the alternative, it claimed £27.2 million in additional resource and third-party costs which it would not have incurred but for IBM’s breaches of contract.
The key question before the Court in relation to quantum was whether the claim for wasted expenditure was excluded by the Exclusion Clause. IBM argued it was a claim for “loss of profit, revenue or savings” (and therefore excluded by the Exclusion Clause). Although the claim referenced the expenditure incurred, the actual loss, IBM argued, was the profit, revenue or savings through which the expenditure would have been recouped, but for the breach.
CIS, unsurprisingly, argued that the claim was not one for loss of profits. Instead, it argued that its financial and non-financial benefits from IBM’s performance of the contract would have been worth at least as much as the amount it expended in reliance on the contract. Its claim for wasted expenditure was, it argued, a claim to put it into a “break-even position” rather than to recompense it for lost profit.
O'Farrell J considered the authorities in relation to this issue at length. Ultimately, she concluded that she had correctly summarised the position in her judgment in The Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Ltd  EWHC 2197 (TCC) in which she held that (emphasis added): “a claim for wasted costs can be explained as compensation for the loss of the bargain based on a rebuttable presumption that the value of the contractual benefit must be at least equal to the amount that the claimant is prepared to expend in order to obtain such benefit.”
Applying that reasoning to the facts, O'Farrell J concluded that the benefit for which CIS had contracted (and which it had lost as a result of IBM’s breach) was the profit, revenue and savings that would have been achieved by a successful implementation of the System. Although the claim was framed as one of “wasted expenditure”, as a claim for lost profits was covered by the Exclusion Clause, re-framing the claim in this manner did not alter that fact: "CIS… is entitled to frame its claim as one for wasted expenditure but that simply represents a different method of quantifying the loss of the bargain; it does not change the characteristics of the losses for which compensation is sought”.
O'Farrell J rejected CIS’ arguments seeking to distinguish the findings in Royal Devon and Exeter on the facts. In that case, the contractual benefit was wholly non-pecuniary, and it was on that basis that a claim for wasted expenditure was held to fall outside of an exclusion clause for loss of profits. Where profit or other pecuniary benefit was not part of the contractual bargain, the loss suffered could not be characterised as profit, revenue or savings. By contrast, in this case the whole purpose of the contract was for CIS to derive a pecuniary benefit.
The key points to take away from this judgment:
- Terminating an ongoing contract for breach is a major step. As this case shows, getting it wrong opens the door to a potentially substantial claim for repudiatory breach of contract. Although ultimately the damages ordered in this claim were not as significant as they might have been, the fact that IBM was exposed to those claims emphasises that it is essential to ensure that any purported or actual termination is carried out in accordance with the contract; and
- Limiting or excluding liability for loss of profits in large IT (and many other) contracts is a relatively standard method of risk allocation. Few contracting parties are prepared to accept unlimited liability for unquantifiable and potentially significant claims over which they have very little control. However, agreeing to exclude liability for claims for wasted expenditure on a failed contract is less typical. It remains to be seen whether this decision will be appealed and what any appellate Court will decide. However, for now, contracting parties need to understand that agreeing to exclude liability for "loss of profits" may well also mean excluding liability for wasted expenditure. If that does not reflect the parties’ agreed positions, careful and clear drafting will be required to accurately represent the intended contractual bargain.
1 For completeness, whilst IBM was found to be in repudiatory breach of the contract, which breach CIS had accepted, O'Farrell J did not accept all of CIS’ claims in this regard. In particular, she held that:
- IBM was not in breach of warranty to take all reasonable steps to ascertain the risks associated with implementing the new IT system;
- IBM was responsible for critical delays to the project in breach of contract and was in breach of its reporting obligations in respect of the delays to the contract;
- CIS did not prove, however, that if IBM had provided more accurate reporting of the delay, it would have terminated the contract early; and
- In purporting to wrongfully terminate the contract, IBM’s actions did not constitute “wilful default” under the contract.