In Soteria Insurance Ltd v IBM United Kingdom Ltd1, the Court of Appeal has clarified the approach to interpreting exclusion clauses. Overturning the first instance decision of O'Farrell J, it found that Soteria's claim for wasted expenditure did not fall within an exclusion of liability clause which excluded claims for 'loss of profit, revenue savings… (in all cases whether direct or indirect)…' (the 'Exclusion Clause'). The Court of Appeal determined that the natural and ordinary meaning of the words used did not exclude wasted expenditure. When analysing an exclusion clause, the more valuable the right, the clearer the language of the clause must be. Had the parties intended the contract-breaker to avoid liability for a 'catastrophic non-performance', clear and obvious exclusionary words to that effect would have been required. Finally, the Court of Appeal concluded there were a number of good reasons for distinguishing wasted expenditure from loss of profits generally. As a result, Soteria's award of damages was increased by some £80 million.
The background to the underlying dispute is summarised in our article on the first instance decision here. In brief, Soteria contracted with IBM to provide a new IT system (the 'System'). The implementation was not a success and following a disputed invoice and disputed attempt to terminate by IBM, Soteria accepted IBM's repudiatory breach of contract and sued for it damages for the failure to implement the System.
Soteria's primary claim was for wasted expenditure of £128 million. In the alternative, it claimed £27.2 million in additional resource and third-party costs which it would not have incurred but for IBM’s breaches of contract.
The decision at first instance
IBM argued the claim was excluded by the Exclusion Clause because the actual loss to Soteria was the profit, revenue or savings through which the 'wasted expenditure' would have been recouped, but for the breach. It therefore fell within the definition of a claim for 'loss of profit, revenue or savings'.
Soteria argued that the claim was not one for loss of profits. Its claim for wasted expenditure was, it argued, a claim to put it into a 'break-even position' rather than to recompense it for lost profit.
At first instance, O'Farrell J concluded that she had correctly summarised the position in her judgment in The Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Ltd  EWHC 2197 (TCC) in which she held that (emphasis added): 'a claim for wasted costs can be explained as compensation for the loss of the bargain based on a rebuttable presumption that the value of the contractual benefit must be at least equal to the amount that the claimant is prepared to expend in order to obtain such benefit.'
However, she held that the 'bargain' made by Soteria was to achieve profit, revenue and savings from the System. Although the claim was framed as one of 'wasted expenditure', fundamentally it remained a claim for loss of profit, revenue or savings and was therefore excluded by the contract.
The Court of Appeal's analysis2
The Court of Appeal3 considered the nature of a claim for wasted expenditure. While the starting point remains the 'compensatory principle', it acknowledged there are difficulties in claims for wasted expenditure where, in reality, the expenditure would never have been recouped even if the contract had been performed (for example, because the contract was a bad bargain).
However, the Court of Appeal concluded that the decision of Leggatt J (as he then was) in Yam Seng PTE Limited v International Trade Corporation Limited  EWHC 111 (QB) was authority for there being a rebuttable presumption that expenditure incurred in reliance on the Defendant's performance of the contract will be recouped.
While Yam Seng addressed the concept of wasted expenditure and the rebuttable presumption, it did not do so in the context of an exclusion clause. The Court of Appeal therefore turned to O'Farrell J's own analysis in Royal Devon and Exeter. In that case, an exclusion clause (similar to the clause in issue in the instant appeal) did not preclude an NHS trust from recovering its wasted expenditure because it was characterised as a claim for the primary benefit of the contract (in that case a functioning system) and not for a subsidiary benefit (such as profit or saving) excluded by the exclusion clause.
However, where the Court of Appeal departed from O'Farrell J was her conclusion that the nature of the wasted expenditure in Royal Devon only fell outside of the exclusion for loss of profit because the contractual benefit was 'wholly non-pecuniary'.
The five reasons why the first instance decision was wrong
The Court of Appeal held there were five main reasons why the decision at first instance was unsound.
- The natural and ordinary meaning of the words
The parties did not include the term 'wasted expenditure' in the exclusion clause. A reasonable person in the position of the parties would not understand 'loss of profit, revenue, savings' as covering a claim for expenditure incurred, but wasted because of the other party's repudiatory breach.
- The proper approach to exclusion clauses
Clear language is needed to exclude obvious remedies. The more extreme the consequences, the more stringent the Court must be before construing a clause in a way which allows a contract-breaker to avoid liability. The clause in issue had not been drafted with sufficient clarity to exclude a claim for wasted expenditure in the event of a repudiatory breach of contract, nothing in its drafting suggested that this outcome ought to arise.
- Distinguishing different types of loss
The types of loss excluded (profit, revenue, savings) were all of a similar kind and could be considered to be types of consequential loss. They each depend on counterfactuals and involve at least an element of speculation. Claims for wasted expenditure are an 'entirely different animal' because they are wholly ascertainable.
- Loss of the bargain
The clause sought to exclude certain types of loss flowing from the underlying loss of bargain but not others. The Court of Appeal construed the bargain as primarily represented by the provision of a functioning IT system, not just (as IBM argued) by the profits, savings and revenue which would be generated by the System.
- Recoupment and the result in Royal Devon The question of construction of the exclusion clause could not turn on whether any given contract was primarily pecuniary or non-pecuniary as that would create extreme uncertainty. There are many contracts where the anticipated benefits might be a mixture of pecuniary and non-pecuniary benefits, for example IT systems which were contracted for to provide greater profits but also greater efficiency and a happier workforce. The Court of Appeal found that although O'Farrell J's finding in Royal Devon that wasted expenditure was, in principle, recoverable was correct, her reasoning that this was only because such expenditure gave rise to a non-pecuniary benefit was unsound.
Limiting or excluding liability for loss of profits is standard in many contracts. Many were surprised, however, by the first instance decision that standard wording used in such clauses also operated to exclude wasted expenditure. Indeed, specific criticism of the first instance decision by Professor Edwin Peel was cited with approval in the judgment.
While every case will turn on its own facts, the Court of Appeal's decision reinforces the English courts' approach to the interpretation of contracts. The Court of Appeal considered a range of issues including the difference between reliance and expectation loss, and the nature of a claim for wasted expenditure.
Fundamentally, however, the primary focus was what the clause in dispute actually said. For a clause to exclude liability for a potentially 'catastrophic' failure of performance, the Court of Appeal confirmed that very clear words would be required. Accordingly, parties who wish to exclude claims for wasted expenditure need to do so expressly, rather than seeking to rely on a general exclusion for loss of profits.