New Classicism? Freedom of Contract, Risk Distribution and Recent Trends in the Drafting of IT Contracts

November 1, 2005

The purpose of this article is to review the current approach of the courts to the following types of clause, all of which seek, in different ways, to distribute risk in IT contracts:

· exclusion and limitation clauses;

· entire agreement and no reliance clauses;

· regulated variation clauses.

The approach of the courts to the interpretation of IT contracts in particular is instructive for two reasons. First, an IT contract often regulates a relationship rather than a one-off transaction; design, procurement and installation agreements are obvious examples where the parties will work alongside each other for extended periods, whilst even a simple software purchase contract will often have a technical support period after initial delivery. The more prolonged the involvement of the parties with each other’s business, the more likely they are to desire a contract which regulates in detail all aspects of that relationship and, above all, the allocation of risk during and after performance. Secondly, the cost and specificity requirements of a major IT project will often mean that the contract is drafted bespoke, with the assistance of legal advisers, by commercial parties of significant (if not always equal) bargaining power. The modern trend is to uphold divisions of risk between commercial parties dealing with each other in such circumstances.

Limitation, Exclusion and Exclusive Remedy Clauses

Historically, exclusion clauses have been treated with a remarkable degree of hostility; doctrines such as “fundamental breach” and “the true construction of the contract” were used to deprive them of any effect.[1] Such techniques are no longer really needed since the Unfair Contract Terms Act 1977 (see Lord Diplock in Photo Production v Securicor [1980] AC 827 (at p 851A)).

The modern approach is that where the parties are commercially aware, are legally advised and negotiate at arm’s length, the court will be slow to interfere with their division of risk in an exclusion or (in particular) a limitation of liability clause. This approach was most clearly and authoritatively stated by Chadwick LJ in Watford Electronics Ltd v Sanderson CFL Ltd [2001] EWCA Civ 317. Sanderson supplied defective integration software to Watford, who terminated for breach and claimed damages. Sanderson relied on clause 7 of its standard terms, which contained provisions for both exclusion of liability for “any claims for indirect or consequential losses” and limitation in the following terms: “In no event shall [Sanderson’s] liability under the contract exceed the price paid by [Watford] . for equipment connected with any claim”.

The Court of Appeal held that the clause was reasonable, Chadwick LJ pointing out (at [54]) the following.

1. There is a significant and obvious risk that bespoke software for a complex business may not perform to the customer’s satisfaction.

2. If it did not do so, there was a real risk that Watford, as customer, might not make the profits it intended to make as a result of the software.

3. Such a risk of consequential loss was within the reasonable contemplation of the parties at the time of contracting.

4. Sanderson, as supplier, was best able to assess the chance that the software might not perform, but Watford was best able to quantify the results of such non-performance.

5. The risk of non-performance was capable of being covered by insurance, but at a cost.

6. Both parties would or should have been able, when making the contract, to have assessed the risk and factored that into the price.

7. Accordingly, the exclusion and limitation were both reasonable, since where, “experienced businessmen representing substantial companies of equal bargaining power negotiate an agreement, they may be taken to have 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 of on the question of 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.”

In SAM Business Systems Limited v Hedley & Co [2002] EWHC 2733 (TCC), HHJ Bowsher QC, in assessing the reasonableness of a limitation clause providing that damages were limited to a “money back guarantee”, asked the question whether the customer (Hedley) was “well able to look after itself”. He found that it was so able and that it had made no attempt to alter the terms of the clause. The judge upheld what he perceived to have been the “freedom of contract” stance of the supplier whose position was that, having taken on the contract on agreed terms, the court should not rewrite those terms to saddle it with a huge risk it had never agreed to assume. On the other hand, had the supplier not included the money back warranty, then the exclusion of liability, however freely agreed, would have been so unreasonable that it would have warranted the interference of the court (see [64] to [73]).

In so finding, HHJ Bowsher relied specifically on the following passage from another IT case, Salvage Association v CAP Financial Services [1995] FSR 654 (at p 676):

“Generally speaking where a party well able to look after itself enters into a commercial contract, and with full knowledge of all relevant circumstances willingly accepts the terms of the contract which provide for apportionment of the financial risks in the transaction . it is very likely that those terms will be held to be fair and reasonable.”

It would however be wrong to suggest that, simply because contracts are negotiated between commercial parties, exclusion and limitation clauses in such contracts will always be upheld. A number of IT cases, albeit pre-Watford, have involved the opposite conclusion.

In the Salvage Association case, a fixed limitation of £25,000 was held to be unreasonably low (not least because soon after this contract was signed, CAP’s management endorsed for use a new standard form limiting liability to £1,000,000).

In St Albans City & District Council v ICL [1996] 4 All ER 481, the Court refused to uphold a limitation clause which attempted to cap ICL’s liability to a fixed £100,000 for a faulty computer system which miscalculated St Albans’s council tax for the following reasons.

1. ICL could not justify the cap of £100,000, which was small in relation to the potential risk (millions) and the actual loss.

2. ICL had insurance cover of £50,000,000 and moreover was of substantial resources; it was part of a group of companies with market capitalisation of over £2,000,000,000.

3. The parties were not of equal bargaining power. Few other companies could supply a suitable system; few would have imposed terms similar to ICL’s. By contrast, the council’s negotiators were inexperienced and under time pressure to get the system installed. There was little involvement of the council’s in-house legal team.

4. ICL were able to insure and had done so; they could defray the cost of that premium to their customers. The council, on the other hand, could only recoup any loss by either cutting costs or charging – and recovering – council tax at a higher rate in the following years.

HHJ Havery QC focused on the inability of the customer to insure and the lack of alternative suppliers of the relevant software product in striking down the limitation clause in Horace Holman Group v Sherwood International Group (unreported 12 April 2000), despite finding that the commercial customer negotiated with its eyes open.

In Pegler v Wang [2000] BLR 218, HHJ Bowsher QC found that clauses excluding liability for consequential loss were unreasonable. However this was largely because the judge found that Wang had completely misrepresented what they were selling to Pegler, and so whilst it, “would be one thing for Wang to include in their contract standard terms intended to exclude liability in the event of some not readily foreseeable lapse on their part, [it would be] quite another to do so when (as here) they had so misrepresented what they were selling that breaches of contract were not unlikely”. In other words, since they had “oversold” the compatibility of the system to such an extent that it was very likely to be defective, it was unreasonable for them to rely on an exclusion clause to avoid liability for the consequences of those defects.

Even if the clause excluding liability for “indirect, special or consequential loss.” had been upheld in Pegler it would largely have been emasculated by the court’s interpretation of this as restricted to losses falling within the second rule in Hadley v Baxendale. This was consistent with the general approach of the courts in taking a broad view of the compass of direct loss (thus falling within the first rule and therefore outside such an exclusion clause) (see also for example Hotel Services v Hilton International Hotels [2001] 1 All ER (Comm) 750).

ICL’s limitation clauses in South West Water Services Limited v ICL (unreported 1999) were also struck down. ICL entered into a contract for the supply of a computer system under which South West Water Services were entitled to a “money back guarantee” if the system failed an “acceptance test”, but if the system were so defective that the contract was terminated before testing, liability was capped at £250,000. HHJ Toulmin CMG QC considered such a clause to be “manifestly unreasonable”.

Whilst it is clear that Watford and SAM epitomise a modern respect for freedom of contract, it is probable that the pre-Watford cases are still relevant to a proper assessment of the reasonableness of exclusion and limitation clauses. They certainly illustrate the complexity of the factual circumstances arising in IT cases where reliance is placed by a party upon such clauses and suggest that an element of unpredictability is likely to continue. In assessing reasonableness the courts will, however, be looking principally at the extent to which one party might be considered to have taken unfair advantage of the other and the extent to which a term looks so unreasonable that it might be concluded that it cannot properly have been understood or considered. If a term does not fail this (fairly restrictive) test then it is likely that it will be upheld as having been agreed as part of the commercial bargain.

Entire Agreement Clauses

By moving increasingly in the direction of holding parties to the express terms of their written bargain, the courts have forced dissatisfied parties to use their ingenuity to raise other challenges to the validity of their contracts.

A favourite avenue of attack has been directed to contract formation, for example by, “threshing through the undergrowth and finding . some (chance) remark or statement (often long forgotten or difficult to recall or explain) on which to found a claim . to the existence of a collateral warranty” (per Lightman J in Inntrepeneur v East Crown [2000] 2 Lloyds Rep 611).

That development has in turn led to a resurgence in reliance on entire agreement and no reliance clauses, by which draftsmen try to pre-empt such attacks. The inclusion of such clauses in contracts is nothing new[2] – it is simply that in recent years the courts have demonstrated an increasing willingness to give them effect.

The modern approach to such clauses echoes the freedom of contract interpretation taken to exclusion and limitation clauses; in contrast to earlier judicial hostility,[3] commercial parties bargaining at arm’s length are now treated as the, “masters of their contractual fate”,[4] free to make “their own law by contracting”.[5] In EA Grimstead & Son Limited v McGarrigan (unreported 27 October 1999) Chadwick LJ recognised explicitly the commercial imperatives driving the inclusion of such clauses, and indicating a willingness on the part of the courts to uphold those aims when he said[6]:

“There are . at least two good reasons why the courts should not refuse to give effect to [such clauses] in a commercial contract between experienced parties of equal bargaining power, a fortiori where those parties have the benefit of professional advice. First, it is reasonable to assume that the parties desire commercial certainty. They want to order their affairs on the basis that the bargain between them can be found within the document which they have signed. They want to avoid the uncertainty of litigation based on allegations as to the content of oral discussions at pre-contractual meetings. Second, it is reasonable to assume that the price to be paid reflects the commercial risk which each party – or, more usually, the purchaser – is willing to accept. The risk is determined, in part at least, by the warranties which the vendor is prepared to give. The tighter the warranties, the less the risk and (in principle at least) the greater the price . It is legitimate, and commercially desirable, that both parties should be able to measure the risk, and agree the price, on the basis of the warranties which have been given and accepted”

It is unsurprising therefore that “entire agreement” clauses excluding reliance on collateral warranties,[7] misrepresentations[8] and terms claimed to be implied from the course of negotiations, trade usage or custom[9] have all been upheld in recent years.

It seems, therefore, that entire agreement clauses are now treated as being effective. But to do what? There are two competing theories. The first is that an entire agreement clause effectively re-writes history, so that it is as if the collateral warranty, representation or implied term was never discussed. This appears to have been the view of Lightman J in Inntrepreneur. The second is that the entire agreement clause places a high, but not insurmountable, evidential hurdle before any claim based on such pre-contract statements. This was the view of the Court of Appeal in Brikom Investments (to which Lightman J was not referred). It was also the view of the Law Commission (Law Com 154 Cmnd 9700 (1986), para 2.15).

The writers suggest much will depend on the form of words chosen, and it is likely that the courts will, in cases of ambiguity, find the clause to be an evidential bar in the way of an allegation that there are other terms outside the contract itself. This must be so, we suggest, since it is possible to imagine extreme situations where even the most strongly worded entire agreement clause could be deprived of effect by what was said before the contract was signed. Say, for example A and B have discussions which would, absent the entire agreement clause, amount to collateral warranties, at the conclusion of which A points to the “entire agreement” clause and enquires how they should deal with their concluded, separate, agreement in light of that clause. If B responded that the entire agreement clause would not apply to their negotiations, it seems logical that such a promise would itself be a collateral warranty depriving the entire agreement clause of effect (see eg J Evans (Portsmouth) v Andrea Mezario [1976] 1 WLR 1078[10]).

Those points aside, we are of the view that if the parties agree an unambiguous clause which “re-writes” (or, more accurately, wipes out) the history of pre-contract negotiations, then effect should be given to their intention as expressed. For reasons of commercial certainty, if a party deliberately signs up to an entire agreement clause which expressly re-writes or wipes out the history of pre-contract negotiations, then it is not unfair to saddle it with the substantial burden of seeking rectification if it wishes subsequently to challenge that clause. The commercial wisdom of such a course may be questionable; but the new classicism requires that commercial parties be held to the terms of a clear bargain, no matter how unwise it might appear with the benefit of hindsight; see, in a different context, Henry Boot v Alsthom Combined Cycles [2000] BLR 247.

Entire Agreement Clauses and No Reliance Clauses

If an entire agreement clause debars a party from laying claim to a collateral warranty or any additional oral term, he may instead allege that he was induced to enter the contract by misrepresentation. To a disappointed party, seeking rescission for misrepresentation may well be attractive. A pre-contractual representation will not be caught by a conventionally worded entire agreement clause because it operates outside the contract (see eg Deepak Fertilisers v ICI where just this occurred).

Again, the ingenuity of litigants has met with a response from the draftsman; entire agreement clauses have been extended to include a second limb dealing with misrepresentations. This is usually drafted in one of two forms:

(a) a simple statement that, “This agreement contains the entire understanding . [and] supersedes all prior representations, writings, negotiations or understandings .”[11] and/or

(b) an express statement of “no reliance” by one or both parties, to the effect that “. no statement or representation made by either party [has] been relied upon by the other in agreeing to enter into the Contract .”[12]

Are such clauses effective? As with entire agreement clauses, various forms of clause which debar reliance on pre-contract representations have been upheld by the courts (see EA Grimstead & Son v McGarrigan (unreported 27 October 1999) and the IT cases of SAM and Watford). However, there has been an important difference in emphasis and reasoning between cases dealing with the first, simpler, form of exclusion clause and those addressing the more sophisticated “no reliance” provision.

The distinction between “no reliance” clauses and the first, simpler form is very important, since in Watford Chadwick LJ stated that “no reliance” clauses were not subject to the test of reasonableness imposed by the Misrepresentation Act 1967, s 3 because it deals only with exclusions or limitation of liability; a “no reliance” clause was not caught because that acknowledgement operated as an evidential estoppel.

On the authority of Watford, a “no reliance” clause will be effective, and will not be caught by s 3, if:

· the acknowledgment of no reliance is clear and unambiguous

· the party making the statement that he has not relied on a representation intends that the other party should act on that statement

· the party receiving the expression of non-reliance believes it, and acts on it (ie by entering into the agreement (see Lowe v Lombard Ltd [1960] 1 WLR 196)).

As a matter of principle, should such a “no reliance” clause be subject to the test of reasonableness for its validity? A number of considerations suggest that it should. First, the law relating to construction of exclusion clauses has always been hostile to arguments that an exclusion clause can escape regulation because it provides “definitions” rather than exclusions. Section 13(1) of the Unfair Contract Terms Act 1977 (which provides that any clause which attempts to exclude liability not by reference to a breach but instead by reference to the “relevant obligation or duty” is nevertheless to be treated as an exclusion clause) exemplifies this “substance not form” approach. On any analysis, the effect of a “no reliance” clause is to exclude reliance on a pre-contract representation. The mischief of s 3 is still engaged irrespective of the form of words used. Finally, it was accepted in Government of Zanzibar v BAE [2000] 1 WLR 2333 that the UCTA 1977 applied to “entire agreement” clauses. In the earlier case of EA Grimstead & Son v McGarrigan, Chadwick LJ had assumed that s 3 did apply to no reliance clauses (although he did not have to decide the point). Watford is, however, current Court of Appeal authority to the contrary. It is also questionable how much of a further hurdle in practice would be added by applying the reasonableness test to the existing requirements for validity.

In SAM, the clause was in the first form and there was no express reference to no-reliance. HHJ Bowsher QC distinguished Watford[13] on this basis, and held that the UCTA 1977 applied to the simple, first form of clause. The onus was therefore upon the party relying on the clause to demonstrate that it was reasonable. HHJ Bowsher found, by reference to the same considerations as have already been outlined above in relation to exclusion clauses, that the exclusion was reasonable: the parties were of equal bargaining power; there was some evidence that other contractors insisted on similar exclusions; whilst the purchaser did not attempt to negotiate more favourable terms.

“Regulated Variation” Clauses

Again, point meets counterpoint; with the courts closing the door on challenges based on pre-contract negotiations, attention shifted to the period of performance. The orthodox view is that the parties’ interpretation of the legal effect of their agreement is of no importance (see James Miller & Partners Limited v Whitworth Street Estates (Manchester) Limited [1970] AC 583). However, English law has never insisted on any formalities to vary an agreement. As a result, consensual performance at odds with the strict terms of a contract has often been argued to amount to a variation. Clauses are now commonly included containing words similar to, “no variation to this agreement shall be valid unless it is made in writing, signed by a director of X, and refers specifically to this clause”[14].

Such clauses appear at first sight to be more difficult to deal with because, unlike entire agreement clauses, clauses attempting to regulate the way in which the parties deal with variations purport to have prospective effect.

This raises the question of the extent to which parties can bind themselves as to future conduct. Unlike entire agreement clauses, there remains considerable doubt as to whether “regulated variation” clauses are effective. In the IT case of World Online Telecom Ltd v I-Way [2002] EWCA Civ 413 the Court of Appeal held that “the law on the topic is not settled” and that it was not an issue suitable for summary judgment. Unfortunately the trial judge did not feel it necessary to decide the issue when he gave judgment after a full trial in 2004.[15]

We consider that “regulated variation” clauses ought to be effective. The mischief they deal with is similar to that addressed by entire agreement clauses and the rationale of holding parties to the terms of their bargain applies with equal force. In the interests of the avoidance of confusion and good commercial administration, such a clause imposes a clear procedure prior to any change in contractual procedure taking effect. Critics point out that if such clauses were effective, they could thwart parties’ subsequent intentions to vary the agreement where the variation failed for a technicality, and further state that this could lead to absurd results; could the courts really uphold the logical extension of a “regulated variation” clause – “this contract cannot be varied whatsoever, in whatever manner”?

We suggest that these criticisms are misconceived. First, the objection that such clauses offend because, unlike entire agreement, they attempt to regulate future behaviour is misconceived. The law of contract is all about regulating future behaviour. There is no conceptual or common-sense reason why the parties should not agree that the terms of the contract itself should not be subject to the same rules as everything which happens under it. Secondly, if they are to be deprived of effect as a matter of general principle, upon what principle might this be based? They can hardly be said to be illegal or void on public policy grounds. On the contrary, they represent a sensible and commercial way of dealing with a familiar problem. Thirdly, there is no reason to try and formulate a general contractual principle on which “regulated variation” clauses are to be deprived of effect, because existing concepts already provide the answer. Waiver, acquiescence, equitable forbearance and estoppel are all still available. Using these principles, a party can in appropriate circumstances be debarred from relying on the absence of a valid variation where it has taken the benefit of performance. Finally, as to the most extreme example – “no variation at all shall be valid” – there seems no reason in theory why such a term should not be effective. Whether it would be commercially wise or feasible to shut out the possibility of ever changing the agreement is another question. In such a case, the parties would still be free to make a new or revised agreement.

We submit that relying on existing doctrines such as estoppel to police any attempted abuse of a “regulated variation” clause makes good sense; if A in fact performs in line with an oral variation agreed with B notwithstanding the absence of writing, existing doctrines will almost invariably debar B, the benefiting party, from refusing to acknowledge that benefit. At the same time, if A refuses to perform in line with a purely oral variation and renders only that performance which he agreed to give B under their original (written) contract, then B cannot be heard to complain; he has got what he originally bargained for, as he has failed to get A to agree to a valid variation.[16]

The increased respect for party autonomy in drafting means that in our view it is likely England will follow the US[17] and hold such clauses valid when, in appropriate factual circumstances, the matter finally comes before the courts for a binding decision.


In our view the new classicism is to be welcomed. IT contracts can be complex and high value with an enormous potential for loss in the event of breach. The decision of the Court of Appeal in Watford, together with the benevolent attitude taken in that and the other cases towards “entire agreement” and “no reliance” clauses, seems to be moving the interpretation of commercial contracts – at least those entered by parties capable of looking after their own interests – back strongly in favour of the classic “freedom of contract” model. This approach helps to achieve the basic objective of all commercial contracts – certainty of the bargain.

Adrian Hughes and James Bowling are barristers at 4 Pump Court, Temple.

[1] See the line of cases in the Court of Appeal ending with the decision in the House of Lords in Photo Production Limited v Securicor [1980] AC 827.

[2] See e.g. Felstone Tile Company Ltd v Winget Ltd [1936] 3 All ER 473 and Brikom Investments v Carr [1979] 1 QB 467.

[3] In Brikom Investments v Carr, Lord Denning was of the view (at 480D) that, “The cases are legion in which such a clause is of no effect in the face of an express promise or representation on which the other side.”

[4] A phrase coined by Bingham J (as he then was) in Pagnan SPA v Feed Products [1987] 2 Lloyds Rep 601 and approved by the Court of Appeal in the same case (ibid., per Lloyd LJ at 619, col. 2).

[5] Per Sedley LJ in I-Way Ltd v World Online [2002] EWCA Civ 413.

[6] He repeated the passage in relation to the entire agreement and “no reliance” provisions in the IT contract under consideration in Watford Electronics v Sanderson CFL Limited [2001] BLR 143 at 154, col. 2.

[7] Deepak Fertilisers v ICI [1999] Lloyds Rep 387.

[8] Govt of Zanzibar v BAE [2000] 1 WLR 2333 per HHJ Jack QC at 2344B – 2347A, although as the Judge pointed out, as a matter of public policy no term of a contract could exclude liability for a fraudulent misrepresentation.  

[9] Exxonmobil Sales & Supply Corpn v Texaco [2004] 1 All ER (Comm) 435 per Nigel Teare QC sitting as a Deputy High Court Judge, at paras 16-27.  The judge was careful to say that an entire agreement clause could not oust a term necessary to give the contract business efficacy where such was “required to make the contract work”.  The writers consider that such terms are implied as a matter of law and therefore are not caught by the mischief of an entire agreement clause.

[10] In that case the defendant freight forwarders A had a contractual discretion as to whether to ship above or below deck.  A and B discussed the clause prior to contracting, during which discussions A promised B that his cargo would be shipped in the hold.  When B’s cargo was subsequently lost when shipped on deck, it was held that B could recover under the collateral warranty.

[11] Clause 3.6 of the contract under consideration in SAM Business Services v Hedley.

[12] Clause 14 of the contract under consideration in Watford Electronics v Sanderson.

[13] Although the judge did not question the correctness of the decision, it is interesting to note that both Counsel agreed that Watford was wrongly decided insofar as it held that the UCTA 1977 did not apply to “no reliance” clauses. 

[14] See e.g. clause 14.1 of the contract under consideration in Inntrepreneur v East Crown.

[15] [2004] EWCH 244 (Comm).  He decided that the alleged variation agreement had never in fact occurred, thus rendering the issue redundant.

[16] Any attempt to proceed against A for its failure to make good its oral promise of enhanced performance under promissory estoppel would, it is suggested, fall foul of the rule that an estoppel cannot be used to found a cause of action, being a “shield and not a sword”.

[17] See I-Way, where a (brave) attempt was made to persuade the CA to hold that English and US law were the same on this point on an appeal from summary judgment.