No IT vendor with any sense would enter into a major contract that did not contain limitations on its liability if the project went wrong. In recent years the courts have been more inclined to uphold the validity of limitation clauses, and as a result unhappy customers in a number of recent cases have sought to sue their IT vendors not only for breach of contract but also for “fraudulent misrepresentation”. Why? Because under English law a limitation clause, however reasonable, cannot be effective to limit liability for fraud.
This approach faced a major test in the £700 million claim lodged by the satellite broadcaster Sky against IT vendor EDS, and judgement of the court was issued on 26 January 2010. The judgement contains a number of lessons for those involved in major IT projects, particularly those involved in selling complex IT solutions.
The facts
Sky engaged EDS in relation to the development of a customer relationship management system focused primarily on call centre services, with a contract value in the region of £54 million. Originally intended to go live on 31 July 2001, Sky claimed that the functionality of the system was only completed in March 2006 a cost of £265 million, and overall it claimed over £700 million in damages. In essence, EDS had oversold in terms of its skills, its resources, and the time and costs it would take to get the system to completion.
The contractual process looked like this: there was a tender process in 2000 involving an Invitation to Tender and a Response from EDS, followed by an initial Letter of Intent so that work could start straight away, then a “Prime Contract” which contained a number of delivery milestones. When things started to go wrong and dates started slipping there was a renegotiation in 2001 which led to a Letter of Agreement which amended some of the terms of the Prime Contract; in particular the Letter was to be “in full and final settlement of: (a) all known claims which [Sky] may have against EDS or which EDS may have against [Sky] for any breach of the Prime Contract as of the date of both parties signing this letter; and (b) all unknown claims which [Sky] may have against EDS or which EDS may have against [Sky] for any breach of the Prime Contract during the period up to and including 17 June 2001.” Then in 2002 Sky took over the performance of EDS’ role of Systems Integrator and a “without prejudice and subject to contract” Memorandum of Understanding was signed further amending the terms of the overall agreement and putting the project onto an incremental basis.
Sky’s allegations were these: EDS had made fraudulent misrepresentations in relation to resources, cost, time, technology and methodology in its Response and in meetings and documents sent by EDS to Sky which led to Sky awarding EDS the Letter of Intent and ultimately the Prime Contract. It also alleged that EDS made negligent misstatements prior to the Letter of Agreement. Sky further alleged that EDS was in breach of contract for failing to meet various contractual milestones. Finally, because the Memorandum of Understanding had been “without prejudice and subject to contract” there was a question mark over what legal effect, if any, it had.
Fraudulent misrepresentation
A fraudulent misrepresentation is a false representation that has been made (1) knowingly; or (2) without belief in its truth; or (3) recklessly, careless whether it be true or false. Further, to succeed Sky had to show (a) that EDS intended that Sky should act in reliance on the representation; and (b) that Sky did indeed rely on the representation to its detriment. If EDS were found to have made fraudulent misrepresentations then nothing in the contractual documents would limit its liability to Sky for losses caused by those misrepresentations.
Negligent misstatement
Liability in the tort of negligent misstatement arises where one party who owes another party a “duty of care” carelessly makes a statement to the other party that is untrue and that party then proceeds to rely on that statement and suffers loss as a result. If EDS did assume such a duty of care towards Sky, and the claims that were made in the Response were inaccurate and made carelessly, and then EDS would be liable for negligent misstatement. However, the later terms of the Prime Contract might reduce or extinguish that liability depending on the precise words used.
Breach of contract and contractual limitations of liability
In the circumstances there was clearly a strong case against EDS in terms of breach of contract since it had clearly failed to meet a number of contractual milestones. The key questions here, however, were whether provisions in the contract which limited EDS’s liability were effective. Firstly there was a term which, in effect, limited EDS’s liability to £30 million. Secondly a clause in the Prime Contract stated that “neither party shall have any liability to the other party in respect of (i) any consequential or indirect loss or (ii) loss of profits, revenue, business, goodwill and/or anticipated savings”.
The judgement
Fraudulent misrepresentation: EDS had claimed, in the Response, in meetings which took place before the Letter of Intent, and in further statements made before the Prime Contract was signed, that it had carried out a proper analysis of the amount of time needed to complete the initial delivery and go live of the contact centre. EDS knew this to be false, but intended Sky to rely on it and Sky did so. This was fraudulent misrepresentation.
Negligent misstatement: EDS claimed that it could not be liable for negligent misstatement because the Prime Contract contained an “Entire Agreement” clause which stated “…this Agreement and the Schedules shall together represent the entire understanding and constitute the whole agreement between the parties in relation to its subject matter and supersede any previous discussions, correspondence, representations or agreement between the parties with respect thereto notwithstanding the existence of any provision of any such prior agreement that any rights or provisions of such prior agreement shall survive its termination”. However, the court concluded that the effect of these words was that the Prime Contract superseded any previous representations, but they did not withdraw earlier representations that were not actually superseded by the words of the Agreement. In the event, the court found that prior to the Letter of Agreement EDS had claimed that it had developed an achievable plan which had been the product of proper analysis and re-planning. This representation was false and was made negligently, and EDS was liable for negligent misstatement.
Breach of contract and contractual limitations of liability: the court found that EDS had failed to properly resource the project and was seriously in delay in carrying out the work and achieving the milestones and deliverables because it had failed to capture the requirements of the project or to manage that process. As a result EDS had failed to exercise reasonable care and skill or conform to good industry practice as required under the terms of the Prime Contract. These were clear breaches of the Prime Contract.
However, the limitations of EDS’s liability set out in the Prime Contract were effective; its liability arising out of the contract (excluding, of course, liability for fraudulent misrepresentation) would not exceed the amounts stated in the limitation clause. In particular, Sky had claimed a significant sum in relation to the loss of certain improvements in functionality that should have been delivered which would have reduced the number of calls that were received by its contact centres, but this was held to be a loss of “anticipated savings” and was therefore expressly excluded by the limitation clause. Note, however, that the clause did not affect EDS’s liability for these “indirect” losses as a result of its fraudulent misrepresentations.
The effect of the Letter of Agreement: EDS claimed that the “full and final settlement” wording of the Letter meant that all claims that could be made by Sky up to and including 17 June 2001 had been settled, whether they were claims for breach of contract or claims, such as misrepresentation, whose facts relied on there being an underlying breach of contract. The court, however, was unimpressed by this argument; the words were sufficient to settle the contractual claims at that time, but did not affect claims of misrepresentation and misstatement.
The effect of the Memorandum of Understanding: because of the “without prejudice and subject to contract” wording used the Memorandum did not have any binding effect on either party.
Conclusions
The court judgement highlights in stark terms for IT vendors the liabilities that they can face for pre-contractual misrepresentations or misstatements, however strong the terms of their contracts might be. In terms of fraudulent misrepresentation, this case was somewhat unusual in that the court found clear evidence of deceit by one senior EDS employee in particular. When it comes to negligent misstatement, if untruths have negligently been told by a party before the contract has been entered into then it is clear that the Court will be very reluctant to allow that party to use a contractual mechanism such as an “entire agreement” clause to escape liability.
The case highlights the need for careful and precise wording where attempts are made to limit a party’s liability arising out of a contract, to exclude or limit the legal impact of things said or done outside the narrow terms of the written contract itself (particularly statements which induce a party into a contract), or to settle an ongoing dispute.
Both Sky and EDS have now gone away to calculate the damages due to Sky in this matter in the light of the judgement, and current estimates suggest this might be in the region of £200 million – less than £700 million originally claimed by Sky, but still a significant amount to lose on a £50 million contract. However, it is highly likely that EDS will appeal this judgement, and IT vendors in particular will need to keep a close eye on how this case develops.
© Taveners January 2010