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What Does 'Contractual Exclusion of Loss of Profits' Mean? Court of Appeal Decides

on Tuesday, 10 May 2022.

Parties to commercial contracts often look to exclude and limit liability. Those clauses can take many forms. Parties often exclude liability for loss of profits, loss of revenue or loss of savings. But what does this mean?

In the case of Soteria v IBM, the High Court decision came in for some heavy criticism for interpreting the words in a way most lay people would not understand. The Court of Appeal has now given its ruling.

Why Soteria Refused to Pay an Invoice

Soteria (previously Co-Op in this case) had sought an expensive new IT system from IBM to run its insurance business. The value of the system to Soteria was tens of millions of pounds. There was a dispute over whether the IT system did what it should and there were serious delays. Soteria refused to pay an invoice and IBM purported to terminate the agreement.

What Did the High Court Say?

The High Court sided with Soteria in finding that the system was not adequate.

The High Court also heard Soteria's claim for damages against IBM. However, Soteria's claim was much reduced because of an exclusion of liability for loss of profit, loss of revenue and loss of savings. The High Court had interpreted this phrase as applying to Soteria's wasted expenditure on the IT system. Its logic was that expenditure fed into profits and, as profits were excluded from being claimed, so was expenditure.

Why Lawyers Were Unhappy with the Decision

Many lawyers found the interpretation hard to understand. They also believed that loss of profits was effectively a future (and hard to quantify) loss, whereas wasted expenditure was a different type of loss altogether, and was more closely related to the item that had not been delivered.

What Did the Court of Appeal Rule?

The Court of Appeal has unanimously overturned the High Court's ruling. The Higher Court has decided that wasted expenditure was something different from lost profits. Soteria could therefore claim for its wasted expenditure.

The Court of Appeal had four grounds for this:

  • It applied a natural and ordinary meaning of the words. On the natural and ordinary meaning, claims for wasted expenditure were not included in 'loss of profit, revenue [or] savings'.
  • Parties would not give up their contractual rights lightly. On a proper approach to interpreting exclusion clauses, clear language would be needed to exclude a valuable right. The more valuable the right, the clearer the words would be needed for an exclusion. Clauses which may have extreme consequences need to be stringently construed.
  • Pre-estimating loss of profit, revenue and savings can be difficult. Ascertaining wasted expenditure on the other hand is much more of a straightforward accounting exercise and the ability to claim it is a valuable right. Parties would have expressly excluded it if this had been their intention.
  • The High Court had been wrong to rule that a customer's loss of bargain consisted just of lost profits, revenue and savings. The main loss was actually a functioning IT system. There are different ways to calculate damages: lost profits, revenue or savings was one way; wasted expenditure was another. Wasted expenditure was not simply a way to assess or claim for lost profits, revenue or savings.

What Does This Ruling Mean for You?

Lawyers and commercial parties will breathe a collective sigh of relief from the Court of Appeal decision. To interpret an exclusion of loss of profits as including the wasted expenditure in a project would have widened the exclusion significantly and not left much to be claimed in the event of a breach. It was surely not what the parties had intended. The Court of Appeal decision is a victory for common sense.

A couple of other learning points:

  • If someone does want to exclude liability for wasted expenditure, they should expressly state this in the contract.
  • The judgment is also a reminder that parties should cover things very clearly in limitation of liability clauses. After the tide has gone the other way in recent cases, the Court is signalling that clear drafting is needed if the parties want to benefit from contractual exclusions or limitations of liability. It is not worth leaving interpretations to chance.

If you would like advice on drafting and negotiating liability and other clauses in your commercial contracts, please contact Paul Gershlick in our Commercial Contracts team on 07795 570072, or complete the form below.

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