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 [2001] 4 Web JCLI 

Watford v Sanderson: The requirement of reasonableness in system supply contracts and more generally.


Elizabeth Macdonald,

Reader in Law,
University of Wales, Aberystwyth.
(e-mail: ezm@aber.ac.uk)

© Copyright 2001 Elizabeth Macdonald.
First published Web Journal of Current Legal Issues in association with Blackstone Press Ltd


Summary

The problem of computer systems which do not do what the customer wanted is becoming familiar. This comment / note is concerned with a particular aspect of the Court of Appeal’s significant decision on such a contract, and such a problem, in Watford v Sanderson – the effectiveness of an exemption clause subject to the requirement of reasonableness under the Unfair Contract Terms Act 1977. In particular, it considers the scope for an appellate court to look at that issue, the recognition that a characteristic feature of such contract may impact upon the application of the reasonableness test, and the significance of the Court’s broader comments on the application of that test in the commercial context more generally.


Contents

Introduction
The facts
The dispute
The requirement of reasonableness - outline
The scope for reconsidering reasonableness on appeal
Application of the requirement of reasonableness – recognising the risk in system supply contracts
Application of the requirement of reasonableness – commercial contracts generally
Conclusion
Bibliography

Introduction

The problem of computer systems which do not do what the acquirer wanted is becoming a familiar one.(1) As such systems are generally supplied under standard form contracts containing exemption clauses, the significant issue will often be the effectiveness of such a clause under the Unfair Contract Terms Act 1977 (UCTA) and, in particular, that Act’s test of reasonableness. This note is concerned with an important recent decision of the Court of Appeal on that issue - Watford Electronics Ltd v Sanderson CFL Ltd [2001] 1 All ER (Comm) 696. Once the facts and the dispute in Watford have been set out the requirement of reasonableness will be briefly outlined, and consideration will then be given to particular aspects of its application in the instant case – the scope for an appellate court to substitute its own views of the reasonableness of a clause, the recognition of the relevance of a characteristic feature of software / system supply contracts in relation to the requirement of reasonableness and the significance of the Court’s comments on the approach to the application of the requirement of reasonableness in the commercial context more generally.

The facts

Watford Electronics Ltd v Sanderson CFL Ltd [2001] 1 All ER (Comm) 696 was concerned with the sale of a computer system. The claimant purchasers, or customers, (Watford) were themselves suppliers of computer products, principally by mail order, and with particular expertise in the supply of personal computers. They had found the need for a computer system to deal with their mail order business and to perform accounting functions. They contracted with Sanderson for standard software (‘Mailbrain’ and ‘Genasys’) which was to be modified to meet their needs. There were three contractual documents which were seen as making up the contract – a sales ‘contract’ for equipment, a software licence for the standard software, and a software modification licence covering stated modifications. The three documents basically contained Sanderson’s standard terms, but Watford had successfully negotiated for a price reduction and some modification of the terms (see below). In the end, the total paid by Watford was £104,596. For our purposes, the significant term of the sales ‘contract’ (which was also reflected in the two licenses) was cl 7 – the exemptions clause. Clause 7(3) stated

“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 Company's liability under the Contract exceed the price paid by the Customer to the Company for the Equipment connected with any claim.”

Watford had sought to have the exemption clause amended but Sanderson would only agree to an addendum to it under which Sanderson committed to ‘their best endeavours in allocating appropriate resources to the project to minimise any losses that may arise from the contract’.

The dispute

The dispute arose because the system did not perform as Watford had wanted. Watford basically claimed that there had been misrepresentations as to its capabilities, breach of implied terms reflecting those representations, and of terms that the system would be merchantable and reasonably fit for the purposes for which it was supplied, and also breach of a duty (as a party with expertise) to use skill and care in recommending a system. There was a contractual claim which totalled about £5.5m and an alternative claim under the Misrepresentation Act 1967 (or for negligent misstatement) for about £200,500. A number of matters were ordered to be tried as preliminary issues and the judgment of the Court of Appeal with which this note is concerned dealt with an appeal on one of them – whether or not cl 7.3 satisfied the requirement of reasonableness under the Unfair Contract Terms Act 1977.

The requirement of reasonableness - outline

Under section 11(1) of the Unfair Contract Terms Act 1977, in order to satisfy the ‘requirement of reasonableness’, the term must have been a fair and reasonable one to have included in the contract having regard to all the circumstances which were or ought reasonably have been known to, or in the contemplation of the parties when the contract was made. In other words, the ‘time-frame’ against which the assessment is made is that of the making of the contract and the actual breach is not relevant to the reasonableness of an exemption clause, merely potential breaches within the reasonable contemplation of the parties when they contracted. The burden of proof lies on the person seeking to rely upon the clause to show that it is reasonable (s11(5)). There are guidelines on reasonableness in schedule 2. They are only relevant by 'legislative prescription' when the requirement of reasonableness is applied by sections 6 or 7, but they are a list of factors which the courts have recognised to be generally factually relevant to the requirement of reasonableness, under whichever section it is applied (eg Phillips Products Ltd v Hyland [1987] 2 All ER 620, p 628). There is also further specific guidance as to the treatment of clauses which limit liability in section 11(4). In relation to such clauses, regard is to be had to the resources available to the person seeking to rely on the clause to meet potential liability and how far it was open to that party to obtain insurance cover. In general, the courts have indicated the relevance of considering the insurance situation eg whether the exemption clause placed the risk of some problem with performance on the person best able to insure and whether the allocation of the need to insure was reflected in the contract price.(2) The application of the ‘requirement of reasonableness’ is basically a weighing process, with the various factors indicating the reasonableness, or otherwise, of the clause, being put in the scales with an appropriate weighting. (On the requirement of reasonableness generally see Macdonald, 1999a)

The scope for reconsidering reasonableness on appeal

It has been made plain that not every decision on reasonableness with which an appellate court does not concur will be one which it will overturn. The scope of this restricted approach to appeals deserves some consideration in the light of Watford v Sanderson.
The restrictive approach to the appellate courts’ powers in relation to a decision on the ‘requirement of reasonableness’ stems from George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd [1983] 2 AC 803. There the House of Lords set out the basic approach to be taken by an appellate court faced with a challenge as to the first instance view of the reasonableness of an exemption clause under UCTA. Lord Bridge said (at pages 815-816):
"It would not be accurate to describe such a decision as an exercise of discretion. But a decision under [UCTA] ... will have this in common with the exercise of a discretion, that, in having regard to the various matters to which ... section 11 of the Act of 1977 [directs] attention, the court must entertain a whole range of considerations, put them in the scales on one side or the other, and decide at the end of the day on which side the balance comes down. There will sometimes be room for a legitimate difference of judicial opinion as to what the answer should be, where it will be impossible to say that one view is demonstrably wrong and the other demonstrably right. It must follow, in my view, that, when asked to review such a decision on appeal, the appellate court should treat the original decisions with the utmost respect and refrain from interference with it unless satisfied that it proceeded upon some erroneous principle or was plainly and obviously wrong"
This was quoted by Chadwick LJ in Watford v Sanderson (para 30) but the court found no difficulty in regarding itself as able to take a different view on reasonableness from the judge at first instance and they had several points to justify that. The fact that the Court of Appeal differed from the view taken at first instance as to the construction of the exemption clause plainly gave them scope to do so, for example.(3) It is self evident that the coverage of an exemption clause is highly significant in the determination of its reasonableness under UCTA.

However, not all of those points require consideration here. What does deserve further consideration is the justification for intervention which the court found in the failure of the judge at first instance to regard a particular fact as relevant to the reasonableness test. At first instance, the fact that the acquirers themselves used a similar exemption clause when they acted as suppliers was not viewed as relevant. The Court of Appeal viewed that as a very relevant factor and its use as such will be returned to below. The point to be made here is that this has been seen as “straying quite close to what Lord Bridge in the George Mitchell case called a ‘legitimate difference of opinion’” (Barker 2001, 348). However, a distinction can be drawn between the situation where an appellate court would differ from a judge at first instance as to the weight to be given to a particular factor in carrying out the weighing process which is required to determine reasonableness under UCTA and the situation in which the courts disagree as to the need to place a particular factor in the scales at all. If the former is not viewed as sufficient to take a case into the area in which Lord Bridge viewed it as appropriate for an appellate court to interfere, the latter can be explained as a different level of disagreement. In fact it may also be seen as desirable that the appellate courts should not feel themselves too constrained by Lord Bridge’s dictum. Professor Goode has commented on the difficulties created for the commercial community in the uncertainty generated by the use of ‘standards’ in the law rather than more certain rules (Goode, 1998, pp 16-17). However, he also made the point that the uncertainty in the initial use of standards may be lessened over time, when decisions have been made as to their content. He said (p 17)

“The distinction between standards and rules does not, of course, remain clear cut, for the courts ... establish criteria by which standards are to be measured, in order to promote consistency in decision making so that over time a standard tends to assume characteristics of a rule”.

Nearly all of the litigation in which UCTA is relevant is commercial. There may be a good reason not to treat Lord Bridge’s dictum too widely.

Application of the requirement of reasonableness – recognising the risk in system supply contracts

The Court of Appeal’s finding of the reasonableness of the exemption clause in Watford v Sanderson has been seen to be of great significance by those concerned in the drafting and negotiating of system supply contracts (eg Barker, 2001; Singleton, 2001, Harvey & Rudgard, 2001). All the more so when it is viewed against the background of the finding of the unreasonableness of the exemption clauses at first instance in other recent cases concerned with system supply contracts (South West Water v ICL [1999] BLR 420, Pegler v Wang (2000) 70 Con LR 68 and Horace Holman Group Ltd v Sherwood International Group Ltd (2000) Unrep, 12th April). Certainly, it is noteworthy in that context for the Court of Appeal’s recognition of one of the characteristics of a contract involving the supply of bespoke or customised software and of its relevance to the requirement of reasonableness.

The more software which has to be written in relation to the supply of a particular computer system, the greater the difficulty involved for the supplier in meeting the expectations of the customer. Firstly, there is the inherent difficulty of those involved in a particular business of communicating to the supplier everything which they require of the system – the customers knows their business and the supplier knows about computer systems and there is often an information gap. Secondly, it should be emphasised that there are great problems in discovering bugs in software. So much so that the point has been explained by analogy with chaos theory. It has been said (Lloyd and Simpson (1994) at 79-80)

"It is impossible to test even the simplest program in an exhaustive fashion. This is because of the myriad possibilities for interaction (whether desired or not) between the various elements of the program ... [Chaos theory] suggests that every event influences every other event; that the beating of a butterfly’s wings has an impact upon the development of a hurricane ... The theory’s hypothesis is reality in a software context. Although software can and should be tested, it has to be accepted that every piece of software will contain errors which may not materialise until a particular and perhaps unrepeatable set of circumstances occurs.”

In the light of such difficulties, the point should be made that in Smith v. Bush Lord Griffiths indicated that a high degree of risk in the contractual performance might indicate the reasonableness of an exemption clause. It can be contended that elsewhere the courts have not taken sufficient note of this in the context of system supply contracts (Macdonald, 1999b). However, it should be emphasised that the point was clearly recognised in Watford v Sanderson. There Court of Appeal recognised the “significant risk that a non-standard software product, ‘customised’ to meet the particular ... needs of a ... relatively complex business ... may not perform to the customer’s satisfaction”. Such recognition is obviously significant if the requirement of reasonableness is to be appropriately applied to contracts for the supply of computer systems or just software.


Application of the requirement of reasonableness – commercial contracts generally

However, the case may be seen to have a much broader significance in the commercial world more generally (Barker, 2001, p 348). Chadwick LJ may be seen as signalling a restrained approach to the use of the requirement of reasonableness in commercial contexts. He said in relation to the supply of a product (para 54)

“In circumstances in which parties of equal bargaining power negotiate a price for the supply of a product under an agreement which provides for the person on whom the risk of loss will fall, it seems to me that the court should be very cautious before reaching the conclusion that the agreement which they have reached is not a fair and reasonable one.”

And more broadly, in relation to commercial contracts generally (para 55)

“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.”

Further consideration must be given to the significance of these comments (and that to similar effect of Peter Gibson LJ at para 63).

The point must be made is that, in one sense, there is nothing new here. In Photo Productions Ltd v Securicor Transport Ltd [1980] AC 827, Lord Wilberforce said (p 843)

“In commercial matters generally, when the parties are not of unequal bargaining power, and when risks are normally borne by insurance, not only is the case for judicial intervention undemonstrated, but there is everything to be said for leaving the parties free to apportion the risks as they think fit and respecting their decisions.”

Although couched in somewhat different terms the basic tenor of this comment can be seen as having much in common with that of Chadwick LJ in Watford v Sanderson. What must be emphasised is that, although cited,(4) this dictum cannot be regarded as having produced a generally non-interventionist approach to the application of the requirement of reasonableness in the commercial context. It cannot easily be predicted that the above dictum of Chadwick LJ will have any greater impact.

In addition, the further point to be made in relation to the above dictum of Chadwick LJ is that it has been emphasised that each case on the requirement of reasonableness is dependent upon its own facts.(5) ‘It may be fair and reasonable to disclaim against X when it would not be fair and reasonable to disclaim against Y’ (Stevenson v Nationwide Building Soc [1984] EGD 934). That militates against the adoption of any general approach to the reasonableness test which takes a non-interventionist approach to commercial contracts generally (Brownsword, 2000, p60). In addition, it must not be forgotten that the burden of proof lies upon the party seeking to rely upon the clause (s11(5)) and, even if Chadwick LJ’s dictum is widely cited and seen as an approach which should be carried into effect, each case will still be dependent upon its own particular facts even if there is a non-interventionist impetus. Two further points must be made in this context. First, the particular facts of Watford v Sanderson indicate very strongly the presence of those factors which Chadwick LJ identified as showing that the courts should leave the bargain as it was made by the parties. Secondly, there may well be particular facts in specific cases which clearly indicate the case to be one in which the court should intervene. Both of these point should be explained further.

In Watford v Sanderson the Court of Appeal clearly identified strong factors against intervention in the contract as made by the parties. The parties were regarded as of equal bargaining power (although there was no other package available on the market which appeared to meet Watford’s needs and system supply contracts generally came with exemption clauses). As has been indicated, it was recognised that the provision of a computer system was one in which there was a ‘significant risk’ that the system would not perform to the customer’s satisfaction, thereby losing the customer profits or efficiency savings. It was also recognised that the risks should have been contemplated by both parties when they made the contract, that the loss was likely to be capable of being covered by insurance (at a cost), and that both of them should have contemplated that the contract price would be affected by who was to bear the risk of that loss. In the instant case, there were seen to be strong indicators that loss should be left where the exemption clause allocated it as the parties had negotiated on the contract price, which had been reduced, and the customer had managed to secure some increase in the undertakings of the supplier (ie as to the use of best endeavours to secure the use of appropriate resources to ensure the system worked correctly). In addition, the customer, Watford’s, understanding of the relationship between the contract price and the allocation of risk (or the need to insure against it) was regarded as made plain by Watford’s own standard terms, which it used when itself supplying items, and which contained an exemption clause which even went so far as to explicitly state that relationship. The facts in Watford can be seen as strongly corresponding to the circumstances which Chadwick LJ identified as showing that the parties “should ... 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.”

In contrast, as has been indicated, the point can also be made that the particular facts of a case may show the need for the courts to intervene by finding an exemption clause unreasonable. So, for example, in the context of system, or software, supply contracts, St Albans City and District Council v ICL Ltd [1996] 4 All ER 481 has been seen as part of the ‘high water mark against limited liability’ (Harvey & Rudgard, 2001, p25), and Pegler v Wang has been seen as part of ‘the high water mark of judicial intervention in limitation provisions’ (Barker, 2000, p 348), but there is a strong basis for contending that both would still be decided in the same way even after the decision of the Court of Appeal in Watford v Sanderson. In the St Alban’s case, the clause in question set £100,000 as the limit of liability, but that limit had been used by mistake. When the particular contract was made, ICL’s standard limit was £125,00 and through ICL’s error a previous version of its standard terms, with the lower limit had been used. Under such circumstances it would certainly be difficult to argue that ICL had regarded the £100,000 limit as a fair allocation of the contract risk. In Pegler v Wang, Wang had misled Pegler as to the ‘fit’ between the standard software they could supply and Pegler’s needs. As has been indicated, it is in trying to adapt software to meet the customer’s needs that the risk in the supply and purchase of computer systems arises. In Watford it had indicated the reasonableness of the clause that both parties recognised the risk and the need to allocate responsibility for it (or insurance against it) and the reflection of that in the contract price. In Pegler v Wang, the misrepresentation of the degree to which the standard software, as such, fitted Pegler’s needs led to the conclusion that it “would be one thing for Wang to include in their contract standard terms intended to exclude liability in the event of some not readily foreseeable lapse on their part, but quite another to do so when they had so misrepresented what they were selling that breaches of contract were not unlikely”. Under such circumstances, there would be no reason to take the Watford view that the court should not interfere with the terms of the contract because the parties should “be taken to be the best judge of the commercial fairness of the agreement which they have made”.

Conclusion

Watford v Sanderson is certainly a noteworthy appellate decision in the area of system supply contracts. It is important for its recognition of a significant characteristic of system supply contracts involving bespoke or customised software – the risk that the system will not do what the customer wanted. Its value as an indicator of the general attitude with which the judges will approach the application of the requirement of reasonableness in commercial contracts more generally is less clear.

Bibliography


Barker, D (2001) ‘A Return to Freedom of Contract’ 151 New Law Journal 344.

Brownsword, R (2000) Contract Law: Themes for the Twenty-First Century (London: Butterworths)

Goode, R (1998) Commercial Law in the Next Millenium (London: Sweet & Maxwell).

Harvey, M & Rudgard, N (2001) ‘The Rebirth of Limited Liability Clauses’ Computers & Law (April/May) 24

Lloyd, I and Simpson, M (1994) Law on the Electronic Frontier Hume Papers on Public Policy, Vol 2, No 4, (Edinburgh; Edinburgh University press).

Macdonald, E (1999a) Exemption Clauses and Unfair Terms (London: Butterworths).

Macdonald, E (1999b) ‘Y2K and Contractual Exemption Clauses’ 1999 (2) The Journal of Information, Law and Technology - http://www.law.warwick.ac.uk/jilt/99-2/macdonald.html

Singleton, E.S (2001) ‘Watford Electronics v Sanderson – Exclusion Clauses in IT Contracts’ 165 Justice of the Peace 346


(1) eg Mackenzie Patten & Co v British Olivetti Ltd (1984) Unrep, 11th Jan, Micron Computer Systems Ltd v Wang (UK) Ltd (1990) Unrep, 9th May, Saphena Computing Ltd v Allied Collection Agencies Ltd [1995] FSR 616, St Alban’s City and District Council v ICL [1996] 4 All ER 481, Pegler Ltd v Wang (UK) Ltd (2000) 70 Con LR 68, Anglo Group plc v Winther Brown & Co Ltd (2000) Unrep, 1st March.
(2) Photo Production Ltd v Securicor Ltd [1980] AC 827, George Mitchell Ltd v Finney Lock Seeds Ltd [1983] 2 AC 803, Smith v Eric S Bush [1989] 2 All ER 514.
(3) The Court of Appeal disagreed with the judge at first instance as to the impact on the construction of the exemption clause (cl 7(3)) of the presence in the contract of an ‘entire agreement’ clause. In the light of the existence of that second clause, the Court of Appeal found that the exemption clause did not cover liability for misrepresentation, merely for breach.
(4) Eg Salvage Assn v Cap Financial Sevices [1995] FSR 654, Chester Grosvenor Hotel Ltd v Alfred McAlpine (1991) 56 Build LR 115, Fillite Runcorn v APV Pasilac (1993) Unrep, 22nd April, Edwards Murray Ltd v BSP International Foundations Ltd (1992) 33 Con LR 1, W Photoprint Ltd v Forward Trust Group (1993) Tr LR 146.
(5) Phillips Products Ltd v Hyland [1987] 2 All ER 620, p 628, Edmund Murray Ltd v BSP International Foundation Ltd (1993) 33 Con LR 1, Sonicar International v East Anglia Freight Terminal Ltd [1997] 2 Ll Rep 48 at 55.


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