Red Sky in the Morning: Sellers’ Warning

May 11, 2010

The supply of booking software to a hotel that proved to be a nightmare to operate, and that led to an award of damages totalling over £110,000, is the context for the latest judgment from the Technology and Construction Court on limitations of liability and the Unfair Contract Terms Act 1977. 

In Kingsway Hall Hotel Ltd v Red Sky IT (Hounslow) Ltd [2010] EWHC 965 (TCC), His Honour Judge Toulmin CMG QC ruled that the attempt to limit damages by the seller (Red Sky) was ineffective and that failures to provide information undermined any claim that the limitation clauses were reasonable. In a long judgment that focuses primarily on the facts, the following extract (at [231]-[258]) summarises the main points of interest on the law, although practitioners may also be interested in the arguments concerning the allowable damages. 

  1. The standard terms and conditions can be summarised as follows:

a) Under clause 2 Red Sky was required to sell the equipment and licence the computer system, provide (if any) the operating documents (paragraph 2.1.5) and provide the services set out in Schedule C (including training) and provide maintenance and support cover.

b) Clause 10.1 excluded all terms as to performance, quality, fitness for purpose etc except as provided in clause 10.2.

c) Clause 10.2 contained an express warranty that “the programmes will in all material respects provide the facilities and functions set out in the Operating Documents.

d) Operating Documents were defined in clause 1.1.6 to include “any operating documents supplied by the defendant to the claimant.”

e) Clause 10.4 provided that the sole remedy for breach of the warranty in clause 10.2 was the Maintenance and Support Cover. The Maintenance and Support Cover was defined by clauses 1.1.4 by the Schedules in the four page signed document, by clause 13 and by clause 28 which set out the hours during which support would be provided and also the response times which could be expected from Red Sky.

f) Clause 10.7 provided that clause 10, together with clause 18 stated the entire liability of the defendant in respect of any fault or error in the IT system.

g) Clause 18 contained limitations and exclusions of liability as follows:

i) Clause 18.3.2 excluded liability for any indirect or consequential loss. The term expressly excluded loss of profits and similar losses

ii) Clause 18.3.3 limited liability for direct loss to four times “Total Price”. By clause 1.1.26 the “Total Price” was £18,250 before discount. A net discount of £1,800 was applied to the contract price for the package. Applying the discount pro-rata to the services gives a figure of £17,615.82. The cap on recovery of damages in this case would therefore be £70,463. These figures are agreed by the parties solely as figures.

h) Clause 23 was an entire agreement clause and clause 26 provided for English law and jurisdiction.

  1. Red Sky contends that clause 10.1 excluded all terms relating to performance, quality, fitness for purpose etc: “to the fullest extent permitted by law.” Therefore the implied terms on which Kingsway relies are incompatible with the express terms of the contract.
  1. In its final submission Red Sky suggests that under the definition in clause 1.1.16, operating documents would include instruction manuals and similar documents setting out how the software was intended to operate.
  1. Red Sky claims that clause 10.4 provides the sole remedy for breach of warranty. The support cover to be provided was defined by clauses 1.14, by the schedules contained in the four page signed documents, by clause 13 and by clause 28. This provides a very high level of support from 7 am to 11 pm each day of the year with an estimated response time of four hours.
  1. Red Sky emphasises that clause 10.7 should be read with clause 18 and provides the further exclusions as follows:

a. Clause 18.3.2 excluded liability for any indirect consequential loss which expressly excluded loss of profits and similar losses.

b. Clause 18.3.3 limited liability for direct losses to the sum of £70,463

  1. While Red Sky accepts that Section 3 of the Unfair Contract Terms Act 1977 (UCTA) applies, it contends that the test of reasonableness is satisfied.
  1. Section 11(1) of the UCTA provides:

“The term shall have been a reasonable one to be included having regard to the circumstances which were or ought reasonably to have been known to or in the contemplation of the parties when the contract was made.” The Guidelines in Schedule 2 are helpful guidelines.

  1. Red Sky claims:

a) That the parties were of equal bargaining power relative to each other. There were over thirty property management systems competing in this highly competitive market.

b) The customer received a significant inducement to agree to the terms in that a significant discount was given and concessions were made on payment terms despite the fact that the contract price was very modest.

c) There was a long course of dealing between the parties so that Kingsway ought to have become aware of the existence of and extent of the terms. Clause 18.3 contained a prominent warning.

d) This was not bespoke software but it was adapted to the special order of the customer in that it would be configured for the particular customer. Entirety was used by a wide range of customers and the consequences of a breach would differ widely depending on which customers were using the software.

  1. Red Sky also relies on section 11(4) of the UCTA which provides that in considering whether or not a clause or clauses in a contract satisfy the requirement of reasonableness, regard shall be had to:

a. “the resources which he could expect to be available to him for the purpose of meeting liability, should it arise.

b. how far it was open to him to cover himself by insurance.”

  1. The position of insurance is not known although Mr Edwards said that he thought cover might have been arranged at Group level.
  1. Red Sky relies in particular on the judgement of Chadwick LJ in Watford Electronics v Sanderson CFL [2001] All ER (Comm) 696 at para 55 page 716 that where experienced business men, representing substantial companies of equal bargaining power negotiate an agreement, they may be taken to have had regard to the matters known to them and to be the best judges of the commercial fairness and reasonableness of the agreement which they have reached including the fairness of each of the terms of the agreement. This, so Red Sky contends, clearly applies to this case.
  1. Specifically, Red Sky contends, that clause 10.2 applies to exclude any terms to be implied under section 14 of The Sale of Goods Act 1979 to the effect that the goods are of satisfactory quality (section S 14(2)) and that where the buyer (as in this case is alleged by Kingsway) makes known to the seller expressly or by implication the purpose for which the goods are bought, that the goods are fit for that purpose.
  1. Red Sky also contends that clause 10.2 would exclude the warranty in Section 4 of The Supply of Goods and Services Act 1982 that the goods were of satisfactory quality.
  1. Kingsway contends, as set out in paragraph 5 of the Reply, that these clauses do not apply since clause 10.2 only applies if there are Operating Documents. The term is defined in clause 1.1.16 of the agreement as “such operating documents as may be supplied by the supplier to the customer in conjunction with the equipment and the Red Sky IT system (as updated, corrected or modified from time to time) and which expression shall include any and all copies of the operating documents which may be supplied by the supplier to the customer. Kingsway contends that no such documents were supplied at the time when Entirety was installed.
  1. Further Kingsway contends that clause 10.2 is not inconsistent with implied terms as to fitness and quality. Kingsway notes that these are Red Sky’s terms and under the contra proferentem rule any doubt or ambiguity in meaning is to be construed against Red Sky.
  1. Further, Kingsway contends that if clause 10.2 must be construed in the manner contended for by Red Sky and the term did otherwise preclude the normal implied terms as to quality and fitness for purpose, it would be unreasonable within the meaning of section 11 of the UCTA because:

1. It would purport to exclude these criteria without substituting any other and would allow a seller to provide unsatisfactory software without any benefit to the purchaser.

2. The terms, other than price were not discussed and conferred no benefit on Kingsway.

3. The bargaining power of the parties was all one way-save for the question of price and payment terms. The contract was entirely under the control of Red Sky – it was a take it or leave it arrangement especially where Kingsway had no real option but to replace the Innsite software as Red Sky had said that they were not going to continue to support it or maintain it.

4. There is no evidence that Kingsway even knew of the existence of the terms of exclusion. Red Sky did not draw it to Kingsways’ notice clearly or at all.

5. Red Sky continued to protest that the goods were off the shelf and were not made specifically for or specifically adapted for Kingsway.

6. Red Sky were specialists in the supply of hotel PMS software.

7. By the date of the agreement, Red Sky had the knowledge of supplying Entirety software to other hotels and were therefore in the best position to assess the likelihood of the existence of any defects and their likely consequences.

8. There is no evidence that one party was in a better position to insure against the risk of the consequences of defects in the software although, given the factors set out in 6 and 7 above, it was a reasonable inference that Red Sky would have been in a better position. Further Mr Edwards seemed to indicate that in fact Red Sky was insured.

  1. Taking these points in reverse order, I conclude that, in principle, the UCTA does apply and that the test of reasonableness is not satisfied. I adopt Kingsway’s’ submissions set out above. I conclude in relation to those submissions that:

1) The parties were not of equal bargaining power.

2) Kingsway and Red Sky bargained on price. Kingsway did not receive any inducement to agree Red Sky’s’ standard terms.

3) On the facts, it is not correct that there was a long course of dealing between the parties such that Kingsway ought to have known the existence of and the extent of the terms.

4) This was not bespoke software.

  1. Further it seems to me that clause 10.1 may provide the key to the answer to the contractual dispute and to the question of the circumstances in which the implied terms as to fitness and quality can properly be excluded.
  1. Red Sky’s contract is predicated on the basis it was able to sell its software as off the shelf rather than customised software and that the manuals, together with the demonstrations of the software, would enable a customer to understand the strengths and the limitations of the software and thus to decide whether it would fulfil its needs. The representations in the manuals would be crucial in explaining to potential customers whether the system provided the level of sophistication and speed which they required. Of course, the operating documents could later be supplemented by further documents which set out the benefits of updates etc.
  1. Without the manuals being supplied before the contract was entered into, it was not possible for potential customers to understand this and to make up their minds whether or not the system would be suitable for their needs. There is no evidence that such documents were provided at the time when the contract was signed. Mr Marshall for Red Sky was forced to say (doing his best) in oral closing that “it is still a valuable warranty even if one does not have the full text of the operating documents” This is not sufficient, even if it is an accurate representation of the factual position. It certainly does not amount to compliance with the contract so as to invoke clause 10.2.
  1. Mr Marshall went on to say that the warranty was that the software would perform “appropriately.” In this case this must mean that the software would perform appropriately “for a hotel which was recommended by Red Sky to use it as being suitable for its needs.” This software was not suitable because in relation to group bookings it had serious defects.
  1. I also accept Kingsway’s submission that clause 10.2 must be construed contra proferentem. In the event of any ambiguity, the clause must be construed against the drafter of the clause i.e. Red Sky. I conclude that operating documents must be construed as being those documents to be supplied by Red Sky either in hard copy or computer readable form which would enable a customer in advance of signing the contract to understand fully the system being offered for sale including the functionality and level of sophistication of the system. This would enable a potential customer to assure himself in the course of a demonstration by Red Sky that its product was suitable for customers needs.
  1. In this case there is also a further complication because the terms of the contract are predicated on the basis that the customer will decide itself whether or not to purchase Red Sky’s product. In this case, I have found that Kingsway relied on Red Sky’s positive recommendation as to the suitability for its purpose in making its decision to purchase Red Sky’s software.
  1. It might be reasonable for the contract to have the effect of precluding the implied terms to satisfactory quality and fitness for purpose where the customer has the means to satisfy itself as to the quality and fitness of the product(Entirety) and does not rely on the advice of Red Sky. In the absence of such a construction of clause 10.2 I am satisfied that the detailed submissions by the claimant are correct and that the UCTA would apply.
  1. I note further in relation to bargaining power, that these were Red Sky’s’ standard terms. Apart from price, this was not a negotiated contract. The Contract was far removed from the circumstance postulated by Chadwick LJ in Watford Electronics.
  1. I should add that on the evidence, Kingsway was in fact induced to purchase Entirety by reason of representations made by Red Sky staff. The standard conditions, as I have said, are predicated on the basis that the customer will receive the operating manuals, have the demonstration and decide for itself.
  1. In Kingsway’s case this did not happen. Kingsway, as I have found, relied on Red Sky’s advice that Entirety would be fit for the purpose of use in a busy central London hotel. Red Sky’s employees knew that group bookings formed an essential part of the system which it was supplying. I conclude therefore that Red Sky’s standard terms excluding liability or limiting damages do not apply.

258.                        To summarise on the Contractual issues:

1. Red Sky’s’ standard terms were predicated on the fact that a prospective customer would investigate Entirety and make up its own mind whether or not to purchase based on demonstrations and the Operating Documents which Red Sky had previously supplied. It did not apply to circumstances in which the customer relied on Red Sky’s’ advice in deciding to purchase Entirety.

2. The exclusions in clause 10.2 only applied where the Operating Documents as defined in Clause 1.1.6 were supplied to the customer before the contract was signed. In this case such documents were not supplied by Red Sky to Kingsway. Therefore, Clause 10.2 and the exclusions derived there from did not apply.

3. In any event, for the reasons set out above, the UCTA Section 11 applies. The terms following which restricted liability were unreasonable to be included having regard to the circumstances which were or reasonably ought to have been known to Red Sky or Kingsway, or be in the contemplation of the parties when the contract was made.

4. Pursuant to S14 of the Sale of Goods Act 1979, a term is to be implied into the contract that Entirety would be fit for the purpose for which it was bought, namely that the system would increase revenue and occupancy levels and would allow quicker check-in and check-out, including accurately processing groups and making changes to group reservations while preserving the accuracy of the system. I am satisfied that Entirety was not fit for the purpose for which it was sold.

5. Pursuant to Section 4 of the Supply of Goods and Services Act 1982 a term is to be implied into the contract that the goods were of satisfactory quality. Entirety did not meet the standard that a reasonable person would regard as satisfactory, taking into account any description of the goods, the price and all other circumstance so as to satisfy S4(2A )of the 1982 Act.

6. Kingsway was entitled, as they did, to reject Entirety which, as delivered, was not of satisfactory quality or fit for its purpose. They were entitled to do so after giving Red Sky every opportunity to improve Entirety, so that it would become of satisfactory quality and fit for its purpose.