IT lawBy Jonathan Cohen, Bird & Bird, LondonLimiting liability in IT supply contractsWatford Electronics Ltd v Sanderson CFL Ltd (Lawtel 23 February 2001; The Times 9 March 2001)The Court of Appeal handed down in February an important ruling on the vexed question of IT suppliers limitation of liability clauses.

This ruling sends out a strong message to the courts that they should not be too ready to strike down such clauses as unreasonable under the Unfair Contract Terms Act 1977 (UCTA).

Watford sells computer products via mail order.

A move to new premises highlighted its need for an integrated software system to run its mail order, marketing and accounting functions.

In April 1992 it began negotiations to purchase a system from Sanderson.

In October 1992 the two parties agreed terms.

They signed a sales contract, a software licence and a software modification licence.

All three contractual documents incorporated Sandersons standard terms and conditions.

Those terms included an entire agreement clause, under which the parties acknowledged that in entering into the contracts, neither had relied on any statements or representations that were not expressly contained in the documents terms.

In addition Sandersons terms contained the following limitation of liability clause: 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 companys liability under the contract exceed the price paid by the customer to the company for the equipment connected with any claim.

This was the limitation clause.That limitation clause incorporated in each of the three contracts a best endeavours clause as follows: In additionSanderson commit to their best endeavours in allocating appropriate resources to the project to minimise any losses that may arise from the contract.

Sanderson agreed to insert this clause as a concession after it rejected Watfords request to modify the terms of the limitation clause.Unfortunately, the system did not perform properly, even with the purchase of additional equipment from Sanderson.

In 1996, Watford decided to replace the entire system.

By that stage Watfords total outlay was approximately 105,000.

Watford issued proceedings for damages for breach of contract in the sum of 5,500,000.

In the alternative, Watford claimed damages for negligence and misrepresentation under the Misrepresentation Act 1967.

In a trial of various preliminary issues in the Technology and Construction Court, Judge Thornton QC held that the limitation of liability clause was unreasonable for the purposes of the Misrepresentation Act 1967, and for the purposes of the Unfair Contract Terms Act 1977.

Sanderson appealed against that specific finding.The Court of Appeals analysisLord Justice Chadwick delivered the leading judgment.

He made three criticisms of the approach adopted by Judge Thornton in assessing whether the limitation clause satisfied the requirement of reasonableness, as defined in UCTA section 11(1).In essence that section provides that in assessing whether a limitation clause is fair and reasonable, the court is to have regard to the circumstances known to the parties when the contract was made.

The judges first error was in identifying the scope of the limitation clause.

He had interpreted it as excluding all claims for damages including damages for pre-contractual misrepresentations.

That interpretation had resulted in his further finding that the limitation clause was unreasonable.Lord Justice Chadwick disagreed with that analysis.

For his lordship, the limitation clause served two purposes: to exclude claims for indirect or consequential losses; and to restrict damages for direct losses to the amount of the price paid by Watford.

The limitation clause could not be read as excluding liability for pre-contractual representations.

This was because the wording of the entire agreement clause already contained an acknowledgement that the parties had not relied on any pre-contractual representations.

Lord Justice Chadwick then criticised the judge for his dismissal of the best endeavours clause as meaningless.

His lordship ruled that the insertion of that clause was significant.

If Sanderson did not comply with its requirements then it could not exclude its liability for indirect or consequential losses under the limitation clause.The third error made by the judge related to the fact that Watfords own standard terms and conditions contained a limitation of liability clause which was very similar to Sandersons.

The judge considered that this was not relevant to his decision.

However, for Lord Justice Chadwick that fact was highly relevant.

It went directly to the section 11(1) issue of the knowledge of the parties at the time the contract was made.Lord Justice Chadwick then applied the UCTA section 11(1) test to the limitation clause, with reference to the guidelines provided at schedule 2.

Both he, and Lords Justices Buckley and Peter Gibson, decided that the limitation clause was fair and reasonable.

Four factors were significant in their assessment: the experience and equal bargaining power of the parties negotiators; Watfords success in securing a reduction in the purchase price; Watfords appreciation of the significance of the limitation clause; and the insertion of the best endeavours clause.Lord Justice Chadwick then gave the following general guidance on the general approach which the courts should adopt in these cases: 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.In this case it could not be said either that there was unfair advantage or that Watford had not properly understood or considered the limitation clause.Ramifications for practitionersThe past few years have seen a flow of first instance decisions striking down supplier limitation of liability clauses as unreasonable.

Practitioners will be aware of cases such as St Albans v ICL, Salvage Association v CAP, South West Water v ICL, and (albeit obiter dicta) Pegler v Wang.

It remains to be seen whether Watford v Sanderson will stem that flow.