How to avoid the pitfalls in the small print

Opinion

How to avoid the pitfalls in the small print

Ian Tranter and Patricia Jones

Ensure you are not trapped by contracts' limited liability clauses.

IT directors and managers should be aware of clauses in IT contracts that seek to exclude or limit the liability of the IT supplier.

Such clauses are commonly used by IT suppliers because they allow the supplier, and its insurers, to predict with accuracy their maximum liability if the contract goes wrong, and to fix the price accordingly.

Essentially what these clauses do is to minimise any damages payable by the IT supplier to the user should the contract fail. Unfortunately, the nature of IT contracts means that the consequences of failure often greatly exceed the price paid for the contract by the user - hence the necessity for suppliers to effectively limit their liability.

If IT suppliers did not do this, the market would see higher prices. It is also true, however, that IT users need to be properly compensated when an IT project goes wrong.

The law in this area seeks to strike a balance and is heavily influenced by the Unfair Contract Terms Act 1977 (UCTA). The effect of UCTA is to strike out contractual limitations (such as a cap on damages) or exclusions of liability that are deemed "unreasonable". A clause that unreasonably limits the amount of compensation payable to the user will be void and the supplier cannot rely on it to prevent the user seeking to recover its losses in full.

The courts' varied approach in interpreting UCTA have included "customer-friendly" decisions in cases such as St Albans City and District Council vs International Computers 1996. The Hertfordshire council had bought a system from ICL to calculate poll tax. The system did not work as expected, losing the council £1m in revenue.

The court held that a cap on liability of £100,000, which was substantially less than the contract price and ICL's insurance cover, was unreasonable and therefore unenforcable.

However, five years later, in Watford Electronics vs Sanderson CFL 2001, the court came down on the supplier's side. It ruled that an exclusion clause limiting its liability was reasonable. The Watford case is viewed by many as a shift towards the fundamental freedom of contract principle, allowing the parties to agree their own contract terms without interference by the courts. Given that suppliers generally limit their liability, this would be bad news for users.

Before even considering the suitability of exclusion or limitation clauses, the user and supplier need to be certain that a contractual relationship exists in the first place. The recent case of Co-operative Group vs International Computers - a three-year legal battle over a till system - has brought into focus the need for a contract to be signed by both parties before the commencement of the commercial relationship.

IT suppliers which begin work on the back of unsigned draft contracts run the risk of contracting without the benefit of any limitation on their liability, while others might unwittingly enter into contracts unintentionally.

The significant increase in business correspondence being conducted via e-mail brings an increased risk that communications by employees who have no authority to make contracts on behalf of their employers could result in a binding contract. The device of a disclaimer on e-mails stating that they will not constitute a binding contract unless supported by a hard copy formal order signed by, for example, a director, can exclude such a risk.

The introduction of an internal e-mail and internet use policy, issued to all members of staff, setting out acceptable use will also reduce the risk. The policy should set out the sanctions for breach and should be enforced vigorously through in-house disciplinary procedures.

The key here is to ensure that the employee understands the limits on their authority to bind the employer into a legally enforceable agreement and to make it clear to any third-party supplier precisely how far the limit of the employee's authority extends. 

Before you sign a contract

IT directors should remember four time-tested principles before signing a contract with a supplier: 

  • Ensure that contracts with IT suppliers are negotiated and agreed in advance by those with authority to bind the company. 
  • Use disclaimers in e-mails to avoid inadvertently legally binding the company.  
  • Always read the small print in IT contracts, in particular any clauses that purport to exclude or limit the compensation payable to the user if a contract goes wrong. 
  • Always try to negotiate with a supplier if a dispute arises. Although the courts will step in to protect users from unscrupulous IT suppliers who seek to rely on exclusion clauses, court proceedings are expensive and it is best to negotiate with the supplier about risk and liability in advance.

Ian Tranter and Patricia Jones are partners at law firm Hammonds

 

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This was first published in October 2004

 

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