Reliance Losses and Exclusion Clauses: Co-Op v IBM

February 25, 2021

If a party to a contract validly terminates following a repudiatory breach, it will be entitled to damages. Such claims are conventionally put in one of two ways:  claims for ‘expectation’, or ‘reliance’ losses. ‘Expectation losses’ generally represent the financial benefits which the party expected to obtain from performance of the contract. In the context of a contract for the provision of a new IT system, these might include increased profits, or savings in operating costs. In many cases, especially where such losses may be difficult to establish or prove, ‘reliance’ losses may provide a more attractive recovery. Such losses comprise the costs which the innocent party has incurred in expectation of contractual performance, for example, the payments made to the former contractor, and third party and internal costs incurred to progress the project (which in many IT projects will be substantial).

Although very different ways of measuring loss, the authorities (and in particular the important judgment of Teare J in Omak Maritime Ltd v Mamola Challenger Shipping Co [2011] 1 Lloyds Rep 47) have emphasised that they are, in principle, alternative approaches to the same exercise. Teare J identified that there were not two different principles at work underpinning reliance and expectation loss claims, but a single principle expressed two ways – seeking to give the innocent party the benefit (but no more than the benefit) which performance of the contract would have provided. This may be quantified either through proven financial benefits which would have been obtained, or the sums expended on the basis of the (rebuttable) presumption that the value of the contractual benefit must be at least equal to those expenditures. For this reason, if a defendant to a claim for reliance losses is able to demonstrate that even had a contract been performed it would still have resulted in a loss to the claimant, a reliance loss claim will not succeed. This is because a claimant is not entitled to be placed by an award of damages in a better position than it would have been had a contract been performed merely by changing the way it frames its damages claim.

The High Court has recently reviewed these authorities, with important ramifications for exclusion clauses in CIS General Insurance Ltd v IBM United Kingdom Ltd [2021] EWHC 347 (TCC). The context was the major litigation between IBM and Co-Op Insurance arising from the failed implementation of a new managed IT system under a contract signed in June 2015. The Court found that, following a dispute regarding payments to IBM, Co-Op had validly terminated the contract for repudiatory breach in July 2017 (although Co-Op was liable to pay a contentious invoice, it had validly put it into dispute, so IBM was not entitled to terminate based on the non-payment). Co-Op made various claims in consequence, including a claim for £128m in wasted expenditure incurred in respect of the project (i.e. its reliance losses).

The contract contained an exclusion of liability for various heads of loss, including “loss of profit, revenue, savings (including anticipated savings) … (in all cases whether direct or indirect) …”. IBM maintained that, on a proper construction, Co-Op’s reliance loss claim was caught by that exclusion. 

In her judgment last week, Mrs Justice O’Farrell reviewed the relevant authorities and took as a starting point the question: what was the benefit for which Co-Op had contracted? The answer, on the evidence, was that it wanted to obtain substantial savings, increased revenues and enhanced profits through the effective use of data within its business which the IBM system was expected to provide. On the basis that the distinction between expectation and reliance losses was the approach to quantifying damages for the losses sustained, rather than distinct forms of loss, the Judge held that the framing of the claim as one for wasted expenditure “simply represents a different method of quantifying the loss of the bargain; it does not change the characteristics of the losses for which compensation is sought.” On this basis, the claim for reliance losses was in substance one for loss of profit, revenue or savings and excluded. 

That finding was very significant for Co-Op’s recovery. Instead of the £128m in reliance losses sought, the Court ultimately concluded that only £15.9m of damages consequential on IBM’s pre-termination breaches was recoverable. 

The judgment could have wide-ranging consequences. Exclusions of liability for lost profits or savings are extremely common in IT contracts, and an authority suggesting that they are apt to preclude reliance loss claims is significant.

Prior to this case, there was an absence of direct authority on this point. In one previous case (Royal Devon & Exeter NHS Trust v Atos [2017] EWHC 2197 (TCC)) a similar argument had been run by the party in repudiatory breach and had failed. There, an NHS Trust had contracted for the digitisation of its medical records. Following delays, it terminated the contract and made a reliance loss claim. The contractor (Atos) unsuccessfully argued that such a claim was precluded by a loss of profit exclusion. However, Mrs Justice O’Farrell pointed out that in the Royal Devon case (in which she had also been the judge) an important distinguishing feature was that the benefit the Trust expected to obtain from performance of the contract was not financial (and so not captured by the word ‘profit’) but intangible (improved clinical outcomes for patients). On this basis, a claim for the loss of the benefit of the contract from which the reliance loss claim derived was not in substance one for loss of profit.

The decision on this point may strike some as surprising. Parties may have particular reasons for wishing to exclude their liability for heads of loss such as lost profits, which are likely to be extremely difficult to predict, hard to quantify in practice and potentially extremely large. Such considerations are likely to apply with less force to a claim to recoup sums spent on a project, which are likely to be easier to anticipate and a good proportion of which will inevitably reflect what the contract provides is to be paid to the defaulting party. On the other hand, it might be said that if the commercial bargain struck by the parties excluded revenue losses, it should not be open to a party to circumvent that bargain by quantifying what in truth is a loss of revenue claim as a reliance loss claim. In any event, it is now clear that if those drafting contracts wish to exclude claims for lost profits but maintain an ability to claim for wasted expenditure it is now clear that they should use very clear words to do so. 

Given the relative lack of direct authority, and the very substantial sums at stake, it would not be surprising if this point were taken to the Court of Appeal. A decision on the point at appellate level would be keenly anticipated due to the ubiquity of loss of profits exclusions, and obvious implications for damages claims. In the meantime, the presence of an effective exclusion of lost profits within a contract will be even more valuable to a party in default.

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Lynne McCafferty QC, 4 Pump Court

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