CIS General Insurance Ltd v IBM United Kingdom

Introduction

It’s a rare occurrence that a technology dispute the scale of CIS v IBM reaches the High Court. And given the time and cost commitment that’s no bad thing. As with almost every large scale technology dispute, there were arguments about failure to deliver what was contracted, disputes about milestone payments, disputed termination rights and some degree of culpability on both sides. So stepping above the detail, what are the 5 key learnings from the case for technology contract negotiators and litigators?

The Facts

CIS (a Co-operative Group insurance company) contracted with IBM in 2015 to design and manage the implementation of a new IT infrastructure. CIS wished to reduce the costs of its legacy systems, to provide tailored services to its customers and to compete as a digital and data based business. However, the implementation did not go smoothly and project was bedevilled by delays.

IBM purported to terminate the contract in 2017 on the basis of an unpaid invoice to the sum of approximately £2.9m. CIS alleged that this was a repudiatory breach of the contract and purported to accept such repudiation. CIS also alleged that IBM’s repudiation was an intentional breach of the contract.

CIS brought a claim for damages of £128m in respect of its wasted expenditure arising out of the alleged wrongful termination by IBM. CIS also claimed that IBM was in breach of contractual warranties to (a) take all reasonable steps to satisfy itself as to all risk, contingencies and circumstances as to its performance of the contract; and (b) report on the progress of the project, including progress of work carried out by IBM’s subcontractor.

IBM disputed any breach of warranty and argued that it had rightfully terminated the contract due to CIS’ failure to pay the invoice.

The court held that the £2.9m invoice was payable but, because it had been disputed by CIS in accordance with an agreed contractual procedure, its non-payment did not entitle IBM to terminate the contract. By nonetheless purporting to terminate, IBM was in repudiatory breach of the contract. However the repudiatory breach was not found to constitute wilful default on the part of IBM and CIS’ claims for breach of warranty, and failure to report on the true status of the project were dismissed. However, IBM was held to be in breach of reporting obligations in respect of delays.

Importantly, CIS’ claim for wasted expenditure failed and CIS was only awarded £15.89m in respect of additional costs incurred as a result of IBM’s wrongful termination and breaches of contract, which needed to be set-off against the unpaid invoice of £2.9m.

5 Key Takeaways

1. How to interpret a commercial contract

The test for contractual interpretation is well known, but the court did everyone a favour by summarising the correct test in one pithy paragraph:

“When interpreting a written contract, the Court is concerned to ascertain the intention of the parties by reference to what a reasonable person, having all the background knowledge which would have been available to the parties, would have understood them to be using the language in the contract. It does so by focussing on the meaning of the relevant words in their documentary, factual and commercial context. That meaning has to be assessed in the light of (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the contract, (iii) the overall purpose of the clause and the contract, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party’s intentions: Arnold v Britton [2015] UKSC 36 per Lord Neuberger Paras.15-23; Rainy Sky SA v Kookmin Bank [2011] UKSC 50 per Lord Clarke Paras.21-30; Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38 per Lord Hoffmann Paras.14-15, 20-25.” [Emphasis added]

Importantly, contractual clauses will be interpreted based on the intention of the parties at the time the contract was entered into. In the context of this case, CIS argued that the disputed invoice was not payable for the milestone in question as it should be dependent on also achieving other separate milestones. The court highlighted that the parties could have chosen to agree that the milestone in question was dependent on the achievement of other milestones but that was not the case based on the contractual drafting and intentions at the time of contracting (such that the only pre-condition to payment was timing of the delivery of this particular milestone).

This serves as a reminder when drafting a contract with structured payments and milestones to be crystal clear on when those milestones will be met and dependencies on other milestones that affect when payment obligations will fall due.

 

2. Beware of “dispute now or pay promptly” clauses. They do work

It is important for customers to comply with "dispute now or pay promptly" clauses. This type of clause was upheld in this case, and requires a party to either promptly notify the other party of a dispute with the invoice or otherwise to pay promptly within a specified timeframe; unless the invoice is disputed (in good faith) then the other party is entitled to the payment.

The clause in question stated:

“Unless the Customer disputes an invoice in good faith in accordance with [the relevant provisions of this Agreement], the Customer shall pay correctly prepared invoices properly submitted in relation to payments to be made under this Agreement within seven (7) Business Days of receipt.

Provided the Customer has given the notice in paragraph 11.11, the Customer may withhold payment of, and meet with the Supplier to discuss, the Disputed Amount…If within (10) Business Days after the date on which the Customer has received the additional details requested from the Supplier, the Disputed Amount has not been agreed, then the Customer and the Supplier shall resolve the matter in accordance with the dispute resolution process.”

Customers can certainly benefit from the inclusion of such a clause as it enables them to effectively withhold payment whilst the invoice remains disputed, provided that the invoice has been correctly disputed in accordance with the clause. However in this case it was the benefit to suppliers that was highlighted. If the contractual framework for disputing the invoice is not followed by the customer then the invoice does need to be paid even if disputed in fact.

 

3. Rights to set off are a valuable tool for customers, but they are narrowed by “dispute now or pay promptly” clauses

Set-off rights, whether set out in the contract or available at equity (in the absence of contractual wording to the contrary) are valuable tools for customers because they allow customers to withhold payments due when the project is delayed and so losses are being suffered, or will be suffered by the customer.

Set-off arises where there are two mutual debts or claims, which are so closely connected that it would be manifestly unjust to allow one party payment without taking into account the cross-claim. As such, the court held that CIS’ claims against IBM for culpable delay in failing to meet key milestones could be set-off against the invoice.

When asking whether set-off applies, the presumption is that parties to a contract will have retained all remedies for breach, including equitable rights such as set-off. Therefore, when drafting, parties should consider whether they wish to exclude the right to set-off claims by express agreement. The court highlighted:

“Clear and unambiguous language will be required before the Court is satisfied that a party has given up valuable rights of set-off; [however] such a stringent test may not be required where a party retains its rights of set-off but agrees that notice conditions apply to the exercise of such rights.”

So in this case, the court considered that the “dispute now or pay promptly” clause was an effective means by which the supplier “cut off” the customer’s set-off rights at [X] days after an invoice was rendered if the customer had not raised its set-off right in that period. Had CIS failed to dispute the invoice within the contractual time period, it would have lost its right to set-off in relation to that particular invoice. This is an important lesson for anyone drafting one of these dispute now or pay promptly clauses. Whilst it is useful for a customer to be able to dispute an invoice and withhold payment, if they do not do so the right to set off may be lost. Note, however, that this does not mean that the right to set-off is lost entirely, a party may still be able to set-off payments against future invoices.

4. Suppliers are not bound by knowledge of subcontractors

Another useful takeaway is that the court held that the contract did not attribute to IBM its sub-contractor’s knowledge for the purpose of IBM’s reporting obligations.

CIS attempted to argue that IBM was immediately fixed with its sub-contractor’s knowledge and, had IBM conducted the work itself rather than sub-contracting, IBM would have inevitably had the relevant knowledge. However, the court found that this argument was fundamentally flawed given that IBM could not carry out the work in-house and required the expertise of the sub-contractor. Overall the court held that a clause imposing responsibility on a party for the performance of its contractual obligations where those obligations are performed by a sub-contractor does not “expressly or implicitly, impute to [the party] knowledge on the part of its sub-contractors”.

Importantly, the court agreed with IBM’s submission that the reporting and management obligations in the contract were personal to IBM, and as such were limited to matters within IBM’s actual knowledge and did not extent to matters only known by its sub-contractor. This is a useful lesson for customers who, following this case, should consider whether they wish to add further drafting into their contract to require the supplier to ensure sub-contractors are obligated to share knowledge with the customer or provide regular reporting updates.

 

5. Clauses excluding liability for lost profits are effective against ‘wasted expenditure’ claims

A claim for such damages will usually be presented in one of two ways: a claim for expectation losses, or for reliance losses. Expectation losses cover the financial benefits the party expected to obtain from performance of the contract, such as increased profits, or savings in operating costs. Reliance losses (or wasted expenditure) covers costs the party has ‘wasted’ in expectation of contractual performance, such as third party and internal costs paid to progress the project. Often a party might bring a claim for reliance losses as they may be easier to evidence but essentially (as confirmed by the court in this case) those claims can’t escape the intent of the limitation of liability provisions even if those have been drafted mainly with expectation losses in mind.

In this case, the contract included a wide exclusion of liability clause with respect of losses. It excluded from liability any losses arising under the agreement which are indirect or consequential losses, or for loss of profit, revenue, savings (including anticipated savings), data, goodwill, reputation (in all cases whether direct or indirect).

CIS was unsuccessful in arguing that its claim for wasted expenditure was not a claim for loss of profit. The key question to ask is: what is the loss of bargain suffered as a result of the breach? In this case, this was comprised of “the savings, revenues and profits that would have been achieved had the IT solution been successfully implemented”. The court held that framing the claim as one of 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” and the claim was therefore precluded as it came under the loss of profit exclusion.

As a result of the failed wasted expenditure claim CIS was awarded a sum significantly lower than it had expected. This serves as an important reminder when negotiating a contract, in particular for IT implementation and management projects where the potential losses can be substantial, to take the time to get comfortable with exclusion clauses and to specifically draft in categories of loss that are agreed to be recoverable.