Y2K and Contractual Exemption Clauses
This article is concerned with the effectiveness of contractual exemption clauses at common law and under the Unfair Contract Terms Act 1977 and the 1994 Regulations on Unfair Terms in Consumer Contracts. It considers such clauses in relation to breaches of contract caused by software 'bugs' both generally and, more specifically, in the context of the Millennium (or Y2K) bug. As well as looking at the situation in which the terms in question are obviously exemptions, it also addresses two less obvious cases: entire agreement clauses and clauses warning a purchaser that goods are not Y2K compliant.
Keywords: Y2K bug, Millennium bug, exemption clauses, Unfair Contract Terms Act 1977, Unfair Terms in Consumer Contracts Regulations 1994.
This is a Refereed Article published on 30 June 1999.
Citation: Macdonald E, 'Y2K and Contractual Exemption Clauses', 1999 (2) The Journal of Information, Law and Technology (JILT). <http://elj.warwick.ac.uk/jilt/99-2/macdonald.html>. New citation as at 1/1/04: <http://www2.warwick.ac.uk/fac/soc/law/elj/jilt/1999_2/macdonald/>
The issue of the extent of contractual liability for a breach often raises a question as to the effectiveness of an exemption clause and it seems likely that problems of contractual damages arising from the Y2K bug will be no different. This article is concerned with the effectiveness of some exemption and related clauses. First, it will outline the basic law. Secondly, it will address the specific problems of warnings as to lack of Y2K readiness and of 'entire agreement' clauses when a party has been wrongly told that there is Y2K compliance. Finally, it will consider the more general issue of the application of the test of 'reasonableness' under the Unfair Contract Terms Act 1977 and of 'fairness' under the 1994 Regulations on Unfair Terms in Consumer Contracts.
The question of the effectiveness of exemption clauses raises three basic issues as to (i) the incorporation of such clauses as contract terms (ii) the construction of the term and (iii) the impact of legislation (See generally Koffman & Macdonald (1998) Chs 9, 10). These matters will be briefly considered in turn.
Exemption and other clauses are incorporated by signature, notice or a consistent course of dealing. Basically signature of a contractual document leads to incorporation of the clauses in it unless a claim of fraud, misrepresentation or non est factum can be made out and it is irrelevant whether the signatory has read the clause (L'Estrange v. Graucob Ltd. (1934)). Incorporation of a clause from a notice or unsigned document depends upon whether reasonably sufficient notice has been given (Parker v S. E. Ry. Co. (1877)). In general, all that is required is reasonably sufficient notice of the existence of the clause and the intent to use it as a contract term (eg Thompson v. L. M. & S. Ry. Co. (1930)). However, where clauses are unreasonable or unusual additional efforts will be required if they are to be incorporated by reasonably sufficient notice (eg Interfoto v. Stilletto Visual Programs (1988)). It has been said that the person who sought to incorporate the clause must 'show that his intention to attach [a] ... condition of that nature was fairly brought to the notice of the other party' (emphasis added. Thornton v. Shoe Lane Parking (1971 ) Megaw L.J. at p. 172).
Incorporation by a course of dealing occurs where there has been a sufficient course of dealing between the parties. Usually it arises in situations in which the contracting process is mishandled. Patently, there can be no incorporation by a particular document into a particular contract if that document is only introduced into the transaction after offer and acceptance has occurred (e.g. Olley v Marlborough Court Hotel (1949)). One party cannot simply state new terms and thereby successfully include them in a contract once that contract has been made. However, if, for example, the parties have an established pattern of contracting on the phone, followed by one party despatching his, or her, standard terms then, in the absence of some protest, at some point those terms will become part of contracts made by the parties because of the pattern of dealing. That incorporation will occur not because of the document despatched in the instant case, which is too late, but because of the document sent in the previous cases (eg Kendall & Sons Ltd. v. Lillico & Sons Ltd. (1969)). Such incorporation occurs 'as a result of past practice by tacit understanding of the parties when the contract is made' (SIAT di del Ferro v. Tradax Overseas SA (1980) Megaw L.J. at p. 56).
At common law, exemption clauses are construed contra proferentem. If a clause is ambiguous it will be construed against the party seeking to rely on it (e.g. Wallis, Son & Wells v. Pratt & Haynes (1911)). Since the advent of the Unfair Contract Terms Act 1977, it has been said that 'strained construction' should not be used (e.g. Photo Production Ltd. v. Securicor Transport Ltd. (1980 p. 851); George Mitchell (Chesterhall) Ltd. v. Finney Lock Seeds Ltd. (1983 p. 810)) and it has also been said that limitation clauses should not be treated with the same rigour as exclusion clauses (e.g. Ailsa Craig Fishing Co. Ltd. v. Malvern Fishing Co. Ltd. (1983)). Despite House of Lords authority, the latter approach can be doubted. The point has been made by the High Court of Australia in Darlington Future Ltd. v. Delco Australia Pty. (1986 p. 391) that 'a limitation clause may be so severe in its operation as to be virtually indistinguishable from that of an exclusion clause'. If what is in question is whether an exemption clause covers liability based on negligence, then the rules derived from Canada Steamship Lines Ltd. v. R. (1952 p. 208) apply. A clause will be construed as covering negligence if it expressly refers to negligence, otherwise, where what is in question is simply a widely worded general clause which might cover negligence, it will be more likely to be found to do so where there is no other realistic basis of liability for the party seeking to rely upon the clause.
The Unfair Contract Terms Act 1977 is basically concerned with exemption clauses, although there are provisions to ensure that its application is not restricted by the form of a clause (sections 3(2)(b), 13(1) see Macdonald (1992)). It basically applies to 'business liability' (section 1) although some contracts are excluded from its scope in whole or in part (schedule 1, e.g. insurance contracts). It applies to terms or notices attempting to exclude or restrict liability for negligence (section 2). It covers terms under which the supplier claims to exclude or restrict liability in relation to certain implied terms as to goods (e.g. section 6 relates to attempts to exclude or restrict liability for breach of the terms implied by sections12-15 of the Sale of Goods Act 1979). More broadly, section 3 covers contracts under which one party 'deals as consumer' or on the other party's 'written standard terms of business'. In some cases the exemption clauses are automatically ineffective (e.g. section 2(1) - terms or notices purporting to exclude or restrict liability for negligently caused death or personal injury), but more commonly, they are ineffective unless they satisfy 'the requirement of reasonableness' (e.g. sections 2(2), 3). Assistance as to the content of the reasonableness test is provided by section 11 and schedule 2.
The 1994 Regulations on Unfair Terms in Consumer Contracts are derived from the EC Directive of the same name (see generally Koffman and Macdonald (1998), Ch.11). Subject to certain exclusions in schedule 1, basically they deal with contracts for the sale of goods or supply of services by a seller or supplier to a consumer. In such contracts, non-individually negotiated terms are subject to a test of fairness, unless they are 'core' terms which are in 'plain intelligible language' (regulation 3). The 'core' terms are price terms and those which define the main subject matter of the contract (regulation 3(2)). Terms are unfair if, contrary to the requirement of good faith, they create a significant imbalance in the rights and obligations of the parties to the detriment of the consumer (regulation 4) and there is also a helpful 'grey list' in schedule 3 of terms which 'may' be unfair. Unfair terms do not bind the consumer, but the contract will continue to do so if it is capable of continuing in existence without the unfair term (regulation 5). The individual consumer may rely upon the Regulations in an action against a seller or supplier but there is an additional and wider means by which the Regulations are enforced. The Director General of Fair Trading is given powers to obtain injunctions to prevent the continued use of unfair terms drawn up for general use (regulation 8). So far the Director General has not had to take action but has obtained the alteration of a considerable number of standard terms by agreement. The changes achieved by the Director General, and the approach he is taking to the Regulations, can be seen in the Bulletins on the Regulations which are produced by the Office of Fair Trading.
In the context of the Y2K bug, a seller or supplier may have included a warning that what is being supplied is not millennium compliant. A number of issues may arise as to the effectiveness of such a warning to shield the seller or supplier from liability. The example of a contract for the sale of goods will be considered.
The seller would be arguing that the warning helped to determine the obligations undertaken by the seller eg that it meant that the scope of the term implied by section14(2) that the goods should be of satisfactory quality did not extend to millennium compliance. More specifically, the argument would be that under section 14(2C) the implied term does not extend to 'any matter making the quality of the goods unsatisfactory - (a) which is specifically drawn to the buyer's attention before the contract is made...'. Obviously questions would arise as to the way in which the warning was given. There will be no difficulty where it was clearly stated and explained to the buyer that the goods were not millennium compliant. However, difficulties may arise where the seller seeks merely to rely upon a written warning, unless it has actually been read by the purchaser. Where the buyer has no subjective awareness of the warning a number of issues need to be considered.
Firstly, consideration should be given to the question of where the warning was to be found. Such a warning might be found with the goods, but if it only appeared inside the packaging containing the goods (e.g. with the instructions as to use) and was not accessible until after the goods had been purchased, the warning would have been introduced into the transaction too late and that would be the case even if it was read by the buyer. Factually it could not be argued to have drawn the buyer's attention to a defect before the contract was made and it could not have been incorporated as a term of the particular contract (Olley v. Marlborough Court Hotel (1949)). It might, however, be part of a contract between parties where there had been a sufficient course of previous dealings between them (Kendall & Sons Ltd. v. Lillico & Sons Ltd. (1969)). Such a course of dealing is only likely to occur in the context of business contracts and is unlikely to occur in transactions involving consumers (compare Hollier v Rambler Motors Ltd (1972) and British Crane Hire Corp. v. Ipswich Plant Hire (1975)).
However, even if a warning that there was no millennium compliance did become a term of the contract - through signature, notice or a course of dealing - it is contended that a warning should not be seen as sufficient to help define the scope of the term implied by section 14(2) simply because it was a term. The process by which clauses can be incorporated as terms can be very artificial. In McCutcheon v. David MacBrayne Ltd (1964), for example, Lord Devlin considered what difference it made to the question of incorporation whether a document had been signed. He said (at 133),
'If it were possible for your Lordships to escape from the world of make-believe which the law has created into the real world in which transactions of this sort are actually done, the answer would be short and simple. It should make no difference whatever. This sort of document is not meant to be read, still less to be understood. Its signature is in truth about as significant as a handshake that marks the conclusion of a bargain.'
However, as has been indicated above, the situations are very exceptional in which signature of a contractual document will not incorporate its terms. The point to be made here is that when such artificiality can be involved in incorporation, the mere status of a warning as a term should not allow it to impact upon the scope of the term implied by section 14(2). Whether or not it affects that scope through section 14(2C)(a) should depend upon its impact on the fact situation as such i.e. did it serve, objectively, to draw the buyer's attention to the lack of millennium compliance at the factual level. It can be emphasised that the point being made here does not mean that section 14(2C)(a) must be applied subjectively. The artificiality with which terms can be incorporated means that there is scope for the attention of a reasonable person not to be drawn to the lack of millennium compliance by a warning incorporated as a contract term. The point has been made in relation to objective knowledge of the exemption clause as a factor relevant to the requirement of reasonableness under the Unfair Contract Terms Act 1977 (see schedule 2) that such 'knowledge' is being taken into account in a context in which 'ex hypothesi the term has been validly incorporated in the contract' (AEG (UK) Ltd. v. Logic Resource Ltd (1996)).
It can be contended that even if a warning is incorporated it should have no effect unless its impact upon the fact situation was sufficient, objectively, to draw the buyer's attention to the lack of millennium compliance, i.e. it should have no impact simply because of its status as a term. However, if the warning was seen as having some effect simply because of its status, its lack of connection with the fact situation should lead to its treatment as an exemption clause under the Unfair Contract Terms Act 1977. Section 13(1) allows terms 'excluding or restricting the relevant obligation or duty' to be treated as terms excluding or restricting liability for the purposes of sections 2 and 5-7 (Macdonald (1992)) and section 6 is relevant to attempts to exclude or restrict the term implied by section 14(2). In cases where the buyer 'deals as consumer' any such attempt is automatically ineffective and, in relation to other buyers, the exemption clause is effective only if it satisfies the requirement of reasonableness.
The further point to be made is that if the warning is a non-individually negotiated term in a contract between a consumer and a seller or supplier, it will be subject to the fairness test under the Regulations. It might be contended that such a clause should be exempt from the fairness test as a core term, 'defining the main subject matter of the contract'. However, there are a number of points at which it can be questioned whether such a term would fall within the 'core' exemption from the fairness test. Firstly, the core exemption only applies to terms if they are in 'plain intelligible language'. Secondly, it is not clear what approach should be taken to determining which terms are part of the definition of the 'main subject matter of the contract'. If what matters is purely the contract terms, as such, without any assessment of the consumer's perceptions of them, it can nevertheless be questioned whether a term merely dealing with one aspect of the quality of the subject matter of the contract is part of the definition of 'the main subject matter of the contract'. However, the Director General of Fair Trading, has indicated an approach which does take account of consumer's perceptions. It has been said that 'it would be difficult to claim that any term was a core term unless it was central to how consumers perceived the bargain' (OFT Bulletin 2, para 2.25).
'Entire agreement' clauses may be used, inter alia, to try to prevent pre-contractual statements having an effect either as terms or misrepresentations. For example (see OFT Bulletin 1, at 15),
'You agree that this Agreement is the complete and exclusive statement between us which supersedes all understandings or prior agreements oral or written, and all representations or other commitments between us relating to the subject matter of this agreement.'
'The Holder admits that having entered into this agreement and becoming bound by its terms and conditions he has not relied on any written or oral representations made by the Authorised supplier or its agents or servants and this Agreement and its terms and conditions contains the whole of the terms agreed and binding on the parties.'
In the context of the Y2K problem, such clauses can be relevant where a contracting party has sought and obtained, before contracting, an oral assurance that there will be no problems caused by the Y2K bug. If it transpires that there was no Y2K compliance, the other party may seek to rely upon an entire agreement clause to prevent such a statement providing the basis of an action. However, despite their widespread use, severe doubts can be cast on the efficacy of entire agreement clauses. When it is sought to use such a clause to deny that a pre-contractual statement was a term or a representation, consideration should be given to the interaction of the clause and the underlying fact situation from which are drawn conclusions as to the existence of terms or representations.
For a misrepresentation to be found there must have been a material statement of fact by one contracting party which induced the other to contract. Entire agreement clauses cannot successfully deny the existence of the relevant reliance when it was present. 'What [is] relied on is a question of fact' (Thomas Witter v. TBP Industries Ltd. (1996) Jacob J at 597) and the fact situation as such cannot be changed by a promise - even a contractual one. Nor can such clauses in themselves be used to turn a statement of fact which is relied upon into a mere statement of belief (Walker v. Boyle (1982)). Of course, such a clause would be effective to prevent a misrepresentation if it was read and understood by the relevant party, before they contracted, and actually did result in them not relying upon the relevant statement in making the contract. In addition, they might be of some evidential value in convincing the court what the relevant fact situation was, although that would be a far more effective argument in the commercial context, with two legally advised parties, than in the consumer context.
Entire agreement clauses should be similarly ineffective, simply as terms, to deny the existence of a term based on a pre-contractual statement, although again, particularly in the commercial context, with two legally advised parties, they may be of evidential value when the fact situation is determined. Their basic ineffectiveness can be illustrated. In Harling v. Eddy (1951) a question arose as to the status of a pre-contractual statement at an auction sale. One lot was a heifer, the appearance of which was such that there were no bids until the seller stepped forward and said that there was nothing wrong with it and that he would absolutely guarantee it in every respect. The purchaser then bid for the heifer and bought it. Within three months it was dead from tuberculosis and the purchaser sought to sue the seller on his statement as to its condition. The seller sought to rely on Condition 12 of the printed conditions of the auction which stated, 'No animal ... is sold with a warranty unless specifically mentioned at the time of offering, and no warranty so given shall have any legal force or effect unless the terms thereof appear on the purchaser's account'. The seller's pre-contractual statement did not appear on the purchaser's account, but the Court of Appeal nevertheless held that it was a term of the contract. They took the construction point that Condition 12 referred to 'warranties' and did not apply to a statement which was a condition of the contract. However, they also took the view that even had that not been the case, the statement would still have become a term. The seller was seen as implying 'that the animal should be sold on the faith of what he stated, to the exclusion of condition 12, or any other condition which might be found in the auction particulars which would of itself appear to exclude any oral statement' (Lord Evershed M.R. at 744). It seems unlikely that the parties thought processes were quite so analytical but this approach reflects the relationship of the clause with the rest of the underlying facts from which the existence, or otherwise, of such terms is established.
However, if such clauses were seen as effective simply because of their status as terms, it would seem that they would be regarded as subject to the Unfair Contract Terms Act 1977. In addition, when such a clause is being viewed as effective simply because of its status as a term in the context of whether there is a claim for misrepresentation, it should be subject to s3 of the Misrepresentation Act 1967. (Section 3 of the 1967 Act subjects exemption clauses dealing with misrepresentations to the same 'reasonableness' test as is to be found in the 1977 Act.)
Finally, the point should be made that in a consumer context, in relation to contracts falling within the Unfair Terms in Consumer Contracts Regulations, it would seem that such terms will generally be unfair, and not binding on the consumer[ 4]. Some entire agreement clauses fall within the list in schedule 3 of terms which 'may be unfair' (para 1(n)). In addition, entire agreement clauses were identified by the Director General of Fair Trading as 'one of the most commonly encountered class of unfair term' and that 'virtually all' of the clauses which had been considered were unfair (OFT Bulletin 1, at 16).
Unless they have an impact upon the fact situation as such, affecting the circumstances from which conclusions are drawn as to the existence of a term or misrepresentations, entire agreement clause will not generally prevent pre-contractual statements as to millennium compliance providing a basis for legal action. Certainly, such clauses will not impact upon consumers.
As has been indicated, clauses excluding or restricting liability will frequently be ineffective under the Unfair Contract Terms Act 1977 unless they satisfy the requirement of reasonableness and that requirement will be considered here. First the basic requirement will be outlined and consideration will then be given to its application in the context of two cases dealing with the supply of software/computer systems. The difficulties the Y2K bug may occasion obviously extend far beyond such cases but at bottom those difficulties are generated by a software problem and the approach of the courts in those cases may provide some illumination. In this discussion, the person for whose benefit the exemption clause has been included in the contract, and who is seeking to use it, will be referred to as the proferens.
It is for the party seeking to rely upon the exemption clause to establish that it is reasonable (section 11(5)) and the assessment is made against the time frame of the making of the contract. Under section 11(1) the term must have been a fair and reasonable one to have included in the contract having regard to all the circumstances which were or ought reasonably have been known to, or in the contemplation of the parties when the contract was made. The actual breach is not relevant to the reasonableness of an exemption clause, merely potential breaches within the reasonable contemplation of the parties when they contracted. There are guidelines in schedule 2. For historical reasons, they are only relevant by 'legislative prescription' when the requirement of reasonableness is applied by sections 6 or 7, but they are a list of factors which the courts have recognised to be generally factually relevant to the requirement of reasonableness, under whichever section it is applied. There is also further specific guidance as to the treatment of clauses which limit liability in section 11(4). In relation to such clauses, regard is to be had to the resources available to the proferens to meet potential liability and how far it was open to that party to obtain insurance cover. In general, the courts have indicated the relevance of considering the insurance situation eg whether the exemption clause placed the risk of some problem with performance on the person best able to insure and whether the allocation of the need to insure was reflected in the contract price. Also, in Smith v Bush (1990 p.858), Lord Griffiths set out a list of four factors he regarded as generally relevant to the requirement of reasonableness - the relative bargaining power of the parties; availability of an alternative source of supply of the contract performance; the nature of the task being undertaken by the proferens (one with a high degree of risk more readily justifying an exemption clause); the practical consequences of the decision on reasonableness, having regard to the sums of money potentially at stake; the ability of the parties to bear the losses involved and the availability of insurance to meet such losses. However, despite these statements as to generally relevant factors, the limited nature of the role of the appellant court in this context should be noted. Recognising that the type of weighing of factors which is required in applying the requirement of reasonableness means that there is scope for a 'legitimate difference of opinion as to what the answer should be', the House of Lords has indicated that 'the appellate court should treat the original decision with the utmost respect and refrain from interference with it unless satisfied it proceeded upon some erroneous principle or was plainly and obviously wrong' (George Mitchell Ltd. v. Finney Lock Seeds Ltd. (1983 ), Lord Bridge at 816). Decisions on the requirement of reasonableness provide only limited guidance.
The first of the specific cases to consider here is The Salvage Assn v. CAP Financial Services Ltd. (1995) which was concerned with two contracts for the design, development and supply of computer accounting software for the plaintiff marine surveying company. After two years the system was not complete and had numerous problems. The plaintiff terminated the second contract (the first being over) and sued the defendant for the contract price (GBP 300,000) and wasted expenditure (GBP 500,000). Inter alia, and the relevant point to be considered here, the defendants sought to rely upon clauses limiting their liability to GBP 25,000 under each contract.
Under sections 2(2) and 3 of the 1977 Act, the question arose as to whether the limitation clauses satisfied the requirement of reasonableness. The judge took the view that (at 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 transaction, I think it is very likely that those terms will be held to be fair and reasonable.'
In the particular case, the parties were viewed as being of equal bargaining power and the contract terms as considered and negotiated over a period of time. Had matters rested there the judge would have accepted that the defendants had established the reasonableness of the limitation clauses. However, there were additional factors to consider. In particular, the defendants had not justified the level of the limitation - it bore no relationship to the value of the contract, to the defendant's turnover, to the level of the defendant's insurance cover, or to the financial risk to the plaintiff. Even more particularly, the GBP 25,000 limit was one which the defendants themselves regarded as inappropriate by the time the contracts with the plaintiffs were made (the new limit decided on was GBP 1,000,000). The judge seems to have viewed this last factor as particularly damning of the defendant's claim that their limitation clause was reasonable, and that might seem to be self evident. However, the test of reasonableness in s11 must be borne in mind - it refers 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' (emphasis added). The defendant's views as to the appropriate level of limitation were obviously known to themselves but it is difficult to see how they could have been within the reasonable contemplation of the plaintiffs. Similarly, the judge considered the actual levels of the defendant's insurance cover (GBP 5,000,000 with an excess of GBP 500,000) and again that would seem to be outside the plaintiff's reasonable contemplation. In Flamar Interocean Ltd. v. Denmac Ltd. (1990), Potter J. made it clear that unless parties have discussed their actual insurance positions before contracting, section 11(1) only allows for consideration of the insurance that was available at the time of contracting. In the absence of such discussions, it is only the possible insurance arrangements that can have been within the reasonable contemplation of 'the parties' (ie both of them) at the time the contract was made. In other words much of what was considered in The Salvage Assn. case in relation to reasonableness was not relevant under the test stated in section 11(1). However, that is not to say that the decision is not justifiable. As has been indicated, under section 11(5) the burden lay on the defendants to establish the reasonableness of their clause and, as was pointed out, they had done nothing to show that the limitation to GBP 25,000 was anything other than arbitrary. In addition, whilst the specifics of the defendant's own view of the limit and its actual insurance position were not relevant, their position more generally (eg size of the company) and the availability of insurance to them clearly were, and might be seen as indicating that the limit was not reasonable. The general point to be made is that the basis of the level of limitation in a clause restricting liability will have to be justifiable if the clause is to be found to be reasonable.
The second case specifically to be considered here is St Alban's City and District Council v. International Computers Ltd. (1995). That case arose because of the Council's decision to install its own computer with appropriate software to deal with the implementation of the Community Charge and with the Council's finances in general. After taking expert advice on tenders, the Council contracted with the defendants, ICL. However, the program proved to be defective and it produced an overstatement, by about 3,000, of the population figure for the Council's area and that led the council to claim a loss of something in excess of GBP 1.3m. The question was whether this was recoverable from ICL. Scott Baker J found a clear breach by ICL of an express term that ICL would provide software which was reasonably fit for the Council's purpose of maintaining and retrieving a reliable register of the local community. ICL claimed to rely on clause 9(c) of their contract to limit their liability to GBP 100,000.
Scott Baker J found that clause was rendered ineffective by the Unfair Contract Terms Act 1977 as ICL could not establish that it satisfied the requirement of reasonableness which was applied under section 3, inter alia. It is that conclusion which must be considered here. On appeal (St Alban's City and District Council v. International Computers Ltd (1996)), the Court of Appeal reduced the damages payable by the defendants for reasons unconnected with the limitation clause. In relation to the application of the reasonableness test, there was reference to the limited intervention approach to be taken to appeals and the Court left that part of the decision untouched. Nourse L.J. did add that he believed 'he would have given the same answer' himself (at 492)).
One point which should be emphasised is that ICL had mistakenly used an earlier version of their standard terms in contracting and the version current at the time of the contract with the Council limited liability to GBP 125,000, rather than GBP 100,000. This, in itself, would seem to have made it very difficult for ICL to argue that the clause was a fair and reasonable one to have included in the contract - as the higher limit was part of the standard terms ICL were then using, it could have been within the parties' reasonable contemplation. However, whilst that error on ICL's part must not be lost sight of, what is of more interest is the judge's general approach to the reasonableness test. He concluded that there were four determining factors showing that the clause was unreasonable. Firstly, he referred to the parties' unequal bargaining power. However, whilst the Council might not have been able to contract without the clause, it was in a very different situation to that of the average consumer. It had legal advisers amongst its employees, for example. Secondly, Scott Baker J emphasised that the defendants had not justified the figure of GBP 100,000 which he regarded as small, both in relation to the potential risk and the absolute loss. Of course, against the background of their use of the wrong version of their standard terms, justifying the precise sum would have been virtually impossible for ICL, but, as has already been indicated, it would seem that in general the level of a limitation will have to be justifiable. The third point made by Scott Baker J was that ICL were well covered by insurance (an aggregate of GBP 50m worldwide) and finally, he looked at the practical consequences of the clause being effective or ineffective. He thought it more appropriate for the loss to be borne by a well insured large company than by the community charge payers of St. Albans. Again the point made above as to consideration of the parties' actual insurance position should be remembered, but the type of cover available could be within the parties' reasonable contemplation In addition, Scott Baker J summarised the factors which pointed to a finding that the clause was reasonable. They were 'that bodies such as computer companies and local authorities should be free to make their own bargain, that the companies contracted with their eyes open, that limitations of this kind are commonplace in the computer industry and that [the software package] was an area of developing technology'. As has been indicated, he considered those latter factors to be outweighed by those indicating the unreasonableness of the clause and, of course, the burden of proof was on ICL to establish the reasonableness of the clause. That weighing exercise should be considered further.
In deciding that the clause was unreasonable the judge placed great emphasis on the size of the company and its insurance. However, it is usual to relate the question of insurance cover to the contract price. Was it clear that, given the risks involved in developing software, that increased liability would not have involved increased insurance costs for ICL and an increased contract price? The need to inquire into such a relationship should be emphasised. Of course, even if a defendant would have had to increase insurance cover, and costs, to increase the limit on their liability, that is not necessarily determinative of the question of reasonableness. In Smith v. Bush, (1990), the fact that surveyors would have had to increase their insurance, and charge their customers more if a disclaimer of liability was ineffective did not render the disclaimer reasonable. The practical consequences of the disclaimer being effective were such that it was regarded as unreasonable and in the St Alban's case Scott Baker J emphasised the practical consequences of the limitation clause being effective and loss falling on the local population rather than on an 'international computer company'. However, the appropriateness of an analogy between the situation of the consumer in Smith v. Bush and the Council in the instant case must be questioned. In Smith v. Bush Lord Griffiths noted that the surveyors were insured and said (at 858)
'Bearing the loss will be unlikely to cause significant hardship if it has to be borne by the surveyor but it is on the other hand quite possible that it will be a financial catastrophe for the purchaser who may be left with a valueless house and no money to buy another'.
The possibility of financial disaster for the individual in Smith v. Bush seems to be very different to the situation of the Council in the St Alban's case even when it is emphasised that the burden would eventually fall on the individuals within the Council's area.
In the consumer context, exemptions are unlikely to satisfy the requirement of reasonableness and may also be subject to the test of fairness under the 1994 Regulations. However, in the commercial context, it can be contended that more account needs to be taken of the special nature of software problems. In Smith v. Bush Lord Griffiths indicated that a high degree of risk in the contract performance might indicate the reasonableness of an exemption. This should be considered in the light of the difficulties in eliminating bugs from software which has been explained by analogy with chaos theory. It has been said (Lloyd and Simpson ( 1994) at 79-80)
'It is impossible to test even the simplest program in an exhaustive fashion. This is because of the myriad possibilities for interaction (whether desired or not) between the various elements of the program ... [Chaos theory] suggests that every event influences every other event; that the beating of a butterfly's wings has an impact upon the development of a hurricane ... The theory's hypothesis is reality in a software context. Although software can and should be tested, it has to be accepted that every piece of software will contain errors which may not materialise until a particular and perhaps unrepeatable set of circumstances occurs'.
Of course, these difficulties may impact upon the content of the contractual performance in itself (eg affecting what will be required for goods to be of satisfactory quality under section 14(2) of the Sale of Goods Act 1979) (see Rowland and Macdonald (1997)), but nevertheless they should be acknowledged in relation to the question of the reasonableness of at least some exemptions. In addition, whilst a high level of insurance may be available to some suppliers, and against that background a limitation may appear to be low, before any such conclusion is reached consideration should be given to another special feature of a breach involving a software bug. The point has been made by Lloyd (1997, at 455)
'if one copy of a software product exhibits defects it may be extremely likely that all products will be so tainted. With manufactured products generally, most defects are introduced at the production stage and affect only a portion of the products in question. A finding that one copy of a software package is [not of satisfactory quality] might, by way of contrast, leave its producer liable to every purchaser.'
This should be relevant when levels of insurance cover are considered in addressing the reasonableness of a limitation clause.
As has been indicated, the basic fairness test under the Unfair Terms in Consumer Contracts Regulations 1994 is whether, contrary to the requirement of good faith, the term creates a significant imbalance in the rights and obligations of the parties to the detriment of the consumer. The question of good faith may involve consideration of procedural matters, such as the availability and intelligibility of the clause to the consumers, but it may also go beyond that and involve substantive issues in cases of extreme imbalance (see generally Beale (1995), Collins (1994)). In relation to the question of a significant imbalance in the rights and obligations of the parties, the Director General of Fair Trading as indicated an approach which basically looks for balancing terms (OFT Bulletin 4, at 22-23).
'When a term looks in itself unfair, we need to establish first that there is no balancing provision - which we interpret as one which: first is as potentially detrimental to the supplier as the term in question is to the consumer, and secondly is obviously linked to it, so that the two, on a common sense view, tend to cancel each other out ... We also look of course at the rest of the contract for any qualifying provision that would tend to remove the possibility of detriment in the term under suspicion, rather than balancing it.'
It would seem that exemption clauses will often be 'unfair'. They are frequently not the most readily available or intelligible of terms and that may show a lack of 'good faith' and balancing terms are difficult to envisage, although some 'qualifying provision' may be a more realistic possibility. In addition, such clauses will often fall within the 'grey list' of terms which may be unfair (see e.g. para 1(b), schedule 3).
The millennium bug raises issues as to the effectiveness of exemption clauses which can arise in relation to any other type of breach. However, it may provide the circumstances for consideration to be given to the specific problems created by defective software. If that does occur, then it is to hoped that the difficulties created by those factors unique to software are fully addressed.
1. There is also a rule of construction under the 1994 Regulations on Unfair Terms in Consumer Contracts. Regulation 6 states, '... if there is doubt about the meaning of a written term, the interpretation most favourable to the consumer shall prevail'.
2. The 'grey list' is of very obscure status. The burden of proving that a term is unfair would seem to lie on the consumer (or the Director General of Fair Trading when the more general action under regulation 8 is in question). Technically, coverage of a term by the 'grey list' does not even reverse that burden. It can be seen however, in the OFT Bulletins, that the list is being very heavily relied upon by the Director General of Fair Trading.
3. On the difficulty of applying the fairness test to terms which are basically of no affect but which may mislead the consumer see Macdonald E, (1999) 'The Emperor's Old Clauses: Unincorporated Clauses, Misleading Terms and the Unfair Terms in Consumer Contracts Regulations' Cambridge Law Journal Forthcoming.
5. The forerunner to the Unfair Contract Terms Act 1977 (Supply of Goods (Implied Terms) Act 1973) applied a reasonableness test to certain exemption clauses in the context of the supply of goods. However, that test was concerned with whether it was reasonable to rely on the clause and the breach was therefore relevant. Cases decided under the older reasonableness test need to be treated with some circumspection to ensure that they are not being referred to for a point which is not relevant to the test under the 1977 Act - eg the relevance of the nature of the breach was referred to in George Mitchell v. Finney Lock Seeds (1983 p. 816) but that case was decided under the older provision.
6. The guidelines are derived from the forerunner to the 1977 Act (Supply of Goods (Implied Terms) Act 1973) which only applied in the context of the supply of goods and that has been carried over into the 1977 Act. However, as indicated, the courts have recognised the general factual relevance of the factors identified in the guidelines in whatever context the reasonableness test is being applied - see e.g. Singer Co. (U.K.) Ltd. v. Tees and Hartlepool Port Authority (1988 p. 169); Stewart Gill Ltd. v. Horatio Myer & Co. Ltd. (1992 p. 262).
7. In Photo Production v. Securicor (1980), where the parties were of equal bargaining power, the clause was regarded as reasonable as it allocated the need to insure to the person best able to do so, and had the other party had to insure, if they had been able to, it would have necessitated an increase in price from the cheap one they had offered. One factor indicating the limitation was unreasonable in George Mitchell v. Finney Lock Seeds Ltd. (1983) was the fact that the party seeking to rely on it could have insured without having to materially increase their prices.
8. H.H. Judge Thayne Forbes Q.C., Official Referee.
9. The definition of 'deals as consumer' under the 1977 Act is not the same as that of 'consumer' under the 1994 Regulations. E.g. under the Act a company can deal as consumer but under the Regulations a consumer must be a natural person - see Koffman & Macdonald (1998).
10. The availability/non-availability of choice of a higher priced, lower risk, contract has been seen as indicating the reasonableness/unreasonableness of exemption clauses under the Unfair Contract terms Act 1977 - e.g. R. W. Green Ltd. v. Cade Bros Farms (1978), Singer Co. (U.K.) Ltd. v. Tees and Hartlepool Port Authority ( 1988 p. 170), Woodman v. Phototrade Processing (1981).