SAM v Hedley’s: The TCC answers the Court of Appeal in Watford Electronics

March 1, 2003

The law to do with the application of UCTA to IT contracts changed dramatically with the decision of the Court of Appeal in Watford Electronics v Sanderson [2001] EWCA Civ 317. That was on appeal from a decision of Judge Thornton QC where Chadwick LJ (giving the leading judgment of the Court of Appeal) echoed the sentiments he had expressed previously in Grimstead v McGarrigan (unreported, 27 October 1999, [1999] CA Transcript 1733). Chadwick LJ stated the basic approach for applying UCTA as follows:

“54. . In circumstances in which parties of equal bargaining power negotiate a price for the supply of product under an agreement which provides for the person on whom the risk of loss will fall, it seems to me that the court should be very cautious before reaching the conclusion that the agreement which they have reached is not a fair and reasonable one.

55. Where experienced businessmen representing substantial companies of equal bargaining power negotiate an agreement, they may be taken to have had regard to the matters known to them. They should, in my view, be taken to be the best judge of the commercial fairness of the agreement which they have made; including the fairness of each of the terms in that agreement. They should be taken to be the best judge on the question whether the terms of the agreement are reasonable. The court should not assume that either is likely to commit his company to an agreement which he thinks is unfair, or which he thinks includes unreasonable terms. Unless satisfied that one party has, in effect, taken unfair advantage of the other – or that a term is so unreasonable that it cannot properly have been understood or considered – the court should not interfere.”

After this judgment, there were questions as to how these words (and the whole of the decision itself) would be interpreted by the judges at first instance in future cases: would there be an attempt to distinguish future decisions so that Watford Electronics was, in effect, confined to its own facts? SAM v Hedley may well provide the answer to that question.

Factual Background

The defendant (Hedley’s) was a small three-location firm of stockbrokers based in Lancashire. The Claimant (SAM) was a small supplier of software with one product – InterSet. InterSet was a software package with a number of modules aimed at those dealing in stocks and shares – such as banks or stockbrokers. A customer might choose to have only a sub-set of the modules on offer, but the software was sold as a developed system.

About the middle of 1999, Hedley’s realised that they might have a Millennium compliance problem with their existing program and so decided to move to a more modern software solution. Following an approach by Hedley’s, SAM sent letters and other materials to Hedley’s in July 1999 describing the software and making a number of claims for it. In particular, the claims being made for InterSet were to the effect that it had a very high degree of automation, and was a system that would be operable by ordinary people, not only technically qualified people. SAM also claimed that InterSet could produce reports not only for Hedley’s own purposes but also such as would enable compliance with the rules laid down by the relevant Regulator. Mention was also made of a ‘money back guarantee’ if the system was unacceptable for Hedley’s purposes.

SAM demonstrated InterSet to Hedley’s in September at which time further claims were made for InterSet which were recorded in minutes taken by SAM. These minutes recorded that further details of Hedley’s operation had been provided to SAM, and that SAM was ‘absolutely confident’ that there were no major technological or functional obstacles to implementing InterSet at Hedley’s. SAM pressed for early contracts so that, on 18 October 1999, Hedley’s signed a licence agreement and a maintenance agreement. The agreed licence fee was £116,000: £58,000 payable on signature, £29,000 on installation and £29,000 on completion (which was defined as the earlier of acceptance or 30 days after notification of installation unless within that period Hedley’s told SAM of any failed acceptance criteria). SAM installed InterSet over the weekend of 18 and 19 December 1999 and ‘go-live’ took place on 20 December.

Many problems appeared immediately after go-live, some were fixed, and speedily too, but others remained and problems continued to arise in the course of using the product. In the end, Hedley’s decided to outsource their requirements to Pershings in January 2001, but did not tell SAM of this until 8 February 2001. On 1 June 2001, the claim form was issued by SAM claiming outstanding sums due under the licence agreement. Hedley’s counterclaimed for substantial damages.

In many ways, the facts found by Judge Bowsher show that just about every aspect of this implementation was tainted in one way or another. For example, the training supplied by SAM was ineffective with the staff of Hedley’s having to coach each other; the data conversion performed by SAM was defective with data converted from the old system showing inaccuracies and continuing problems with the software meant that Hedley’s had to report its own deficiencies to the regulator, leading to a requirement of daily reporting and the appointment of KPMG as auditors for Hedley’s.

The Relevant Clauses

Judge Bowsher made a number of distinctions between the clauses in this case and those in Watford Electronics v Sanderson, so it is as well to set out the relevant provisions in full.

Clause 2.10:

“30 days from delivery of the application software by SAM, acceptance tests will be completed by [Hedley’s] in order to test the application software . [Hedley’s] will advise SAM of any instance where the application software fails to achieve the stated acceptance criteria. Such advice shall be in writing . Any individual software component reissued by SAM . may be subjected to retesting by [Hedley’s] for a further 30 days . If, having followed these procedures, and within 90 days from the original date of delivery, there remain acceptance criteria correctly notified by [Hedley’s] according to the procedures outlined above but not achieved by the application software, [Hedley’s] shall be entitled to initiate procedures for rejecting the application software. In the event that SAM consider the rejection of the application software to be unreasonable, SAM shall have the right to request [Hedley’s] to enter into arbitration via an independent third party, and [Hedley’s] shall not unreasonably refuse this request. In the absence of a valid written advice from [Hedley’s], detailing unacceptable behaviour of the application software, and referencing a particular acceptance criterion not attained, the application software will be deemed accepted.”

Clause 2.11:

“In the event of the application software not being accepted according to the obligations and procedures outlined in sections 2.9 and 2.10, [Hedley’s] shall have the right at its entire discretion to rescind this agreement and to be repaid all sums which have previously been paid to SAM in respect of the licence under this agreement. This shall be the sole and exclusive remedy available to [Hedley’s] in the event of the application software not being accepted.”

Clause 3.2:

“. Except as set out in the preceding paragraphs of this section 3.2 [which included a warranty against infringement of intellectual property rights], there are no warranties, either expressed or implied, by this agreement. These include, but are not limited to, implied warranties of merchantability or fitness for a particular purpose, and all such warranties are expressly disclaimed to the extent permissible by law.”

Clause 3.3:

“Except as provided in clauses 3.2 and 3.3, SAM will not be responsible for any direct, incidental or consequential damages such as, but not limited to, loss of profits resulting from the use of the software, even if SAM have been advised of the possibility of such damage.

Except as provided in clauses 3.2 and 3.3, any liability to which SAM might otherwise become subject shall, in aggregate, be limited to the licence fee paid.”

Clause 3.6:

“This agreement constitutes the entire understanding between the parties relating to the subject matter of this agreement and, save as may be expressly either referenced to or referenced herein, supercedes [sic] all prior representations, writings, negotiations or understandings with respect hereto but nothing in this section 3.6 shall exclude liability for any fraudulent misrepresentation.”

The Law

The aspects of the law applied by Judge Bowsher focused on the following issues.

What is the legal status of a bug?

The law on this matter had always been somewhat unsettled, with a number of different cases giving differing views as to the status of ‘bugs’ in software. The prevailing view seemed to be that bugs were an inevitability – something that any user simply had to expect. The courts were in a few cases working out the consequences of this, but the conclusion seemed to be that the law would, in many cases, accept that bugs were a feature of software that a user had to live with. For example, in Eurodynamic Systems v General Automation Limited (unreported, 6 September 1988) Steyn J said:

“The expert evidence convincingly showed that it is regarded as acceptable practice to supply computer programmes [sic] (including system software) that contain errors and bugs. The basis of the practice is that, pursuant to his support obligation (free or chargeable as the case may be), the supplier will correct errors and bugs that prevent the product from being properly used. Not every bug or error in a computer programme [sic] can therefore be categorised as breach of contract.”

Reference might also be made to Saphena Computing v Allied Collection Agencies Limited [1995] FSR616, where Staughton LJ in the Court of Appeal said “Just as no software developer can reasonably expect a buyer to tell him what is required without a process of feedback and reassessment, so no buyer should expect a supplier to get his programs right first time.”

Of course, the decision in St Albans v ICL [1996] 4 All ER 481 by the Court of Appeal might be seen as some indication to the contrary. In this well known case, software supplied by ICL miscalculated the number of taxpayers and thus prevented the claimant from receiving the proper amount of tax due. Nourse LJ in the Court of Appeal said:

“Parties who respectively agree to supply and acquire a system recognising that it is still in the course of development cannot be taken, merely by virtue of that recognition, to intend that the supplier shall be at liberty to supply software which cannot perform the function expected of it at the stage of development at which it is supplied.”

The trend seemed to be emerging that minor glitches in software could be classified as inevitable ‘bugs’ and sounded in no legal liability (Eurodynamics, Saphena) whereas if the software did not do what it was supplied to do, that was a defect and rendered the supplier potentially liable (St Albans).

If the view that had emerged was that users should be prepared to put up with glitches in software, that met with short shrift before Judge Bowsher:

“I am in no doubt that if a software system is sold as a tried and tested system it should not have any bugs in it and if there are any bugs they should be regarded as defects. Of course, if the defects are speedily remedied without charge, it may be that there will be no consequential damage.”

Judge Bowsher seemed to be contrasting ‘bugs’ with ‘defects’. He seemed to use the former to mean errors in software which had no contractual implications whereas the latter most certainly did. ‘Defects’ meant that the user had an action against the supplier: it might well be that swiftly remedying the defect meant that there would be no loss, but the supplier would still technically be in breach of contract for supplying software with a bug in it.

The caveat that must be entered to all this is that Judge Bowsher was talking about ‘tried and tested’ software, not bespoke software systems. The law applicable to such software is probably still to be found in Saphena and St Albans. However, the truism in the industry that all software has bugs and any user has to live with them is a statement that must now be regarded with some (legal) caution. According to Judge Bowsher, if software supplied as a ‘tried and tested’ package must be bug-free, this is a new and higher standard of perfection than seemed to exist before.

Limits of liability

Judge Bowsher is careful in his judgment to ensure that he is seen to follow the Court of Appeal in Watford Electronics. For example, in relation to entire agreement clauses, he says that the authority of Watford Electronics is ‘unquestioned’ as far as he is concerned and declined to hold that the decision in that case was per incuriam. It will be recalled from the Watford Electronics case that the Court of Appeal took the unusual step of interfering with the decision of the judge at first instance, and gave three instances of where that judge’s approach had been wrong.

That being so, Judge Bowsher followed what Chadwick LJ said in that case as being the proper approach. This involved two steps: firstly, ascertain the proper construction of the clauses in question and secondly, on that construction, determine if the clauses are reasonable within the meaning of UCTA. Judge Bowsher did not dwell on earlier decisions in the TCC, such as his own comments in Pegler v Wang (2000) 70 Con LR 68, or those of Judge Toulmin in South West Water v ICL [1999] B LR 420, but rather applied the law following Watford Electronics. In doing so, he reviewed the reasonableness of each term to which UCTA applied but, as Chadwick LJ said [50] in Watford Electronics of the two principal terms in that case, “in considering whether that requirement [of reasonableness] is satisfied in relation to each term, the existence of the other term in the contract is relevant”. This meant for Judge Bowsher:

“. I might find that the virtually total exclusion of liability for breach of warranties is unreasonable but at the same time find that the limitation of the amount of liability to getting one’s money back is reasonable. Or I might find that because of the ability to get one’s money back under the Acceptance Criteria machinery, the exclusion of other liability including the liability in tort or under the 1967 Act for precontractual statements is reasonable.”

In applying the law, Judge Bowsher reviewed a wide variety of factors. These included those listed in Sch 2 to UCTA, such as insurance, availability of other terms, the failure of Hedley’s to negotiate the terms offered, and the totality of the terms – particularly the fact that pre-contract, and also included in the contract, was an offer to repay all sums to Hedley’s if they rejected the system.

This last item was clearly crucial for Judge Bowsher [72]:

“If SAM had not offered what [was] called ‘a standard money back guarantee on licence’ I would have regarded the exclusions of liability and entire agreement clauses as quite unreasonable though I would have regarded the limitation of liability to the amount of money paid under the licence agreement as reasonable.”

Also relevant to Judge Bowsher were the facts that the parties were of roughly equal bargaining power in terms of their sizes and resources, and that Hedley’s had put itself in a difficult position because of the imminence of the perceived Year 2000 problem.

For the moment, it seems that the decision of the Court of Apppeal in Watford Electronics has therefore wrought a significant change in the way in which the courts will approach the limitation and exclusion clauses used by IT suppliers. It is worth bearing in mind that Judge Bowsher stresses at several points that he was concerned only with the particular clauses before him, and it should also be borne in mind that SAM did not, as it happened, carry insurance and both parties were relatively small. However, even bearing these points in mind, he made it abundantly clear that he was following Watford Electronics. This in turn means that the trio of decisions on reasonableness at first instance (South West Water v ICL, Pegler v Wang and Horace Holman v Sherwood International) are probably no longer useful as guidance to the application of UCTA in IT disputes.

Richard Stephens is a Partner, at Field Fisher Waterhouse.

A full report of the case is available at


* The other case in which an IT supplier fared well was Co-operative Group (CWS) Limited v ICL [2003] EW HC 1 (TCC). This is the subject of a Web article by Harry Small of Baker & McKenzie, who acted for the successful defendants. Curiously, counsel for the losing claimant in that case – Richard Mawrey QC and Terence Bergin – were also representing the parties in SAM v Hedley, this time with Richard Mawrey QC representing the defendant and Terence Bergin the claimant.