Advanced IT Contracting: Allocating and Managing Liability – Cases and Princples

Liability Risks

• No given range to liability risk

• Like any commercial contract subject to the size of contract and the size of the effect of breach

• Common issues and occurrences:

• Failure to perform and wasted expenditure• Lost profits/savings• Third party liability – IP, data breaches, privacy

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• Limitation of liability clauses in IT contracts are generally enforceable by Canadian courts

• Limited case law in this area in Canada

• The limitation on the limitations:

• Judicial sympathy/distaste • Evidence on intent and extent of limitation provisions• Confusion or ambiguity in terms• Unconscionability

• The results: hope, despair, uncertainty, hope

Freedom of Contract (sort of) to Limit Risks

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Hope: Clear Terms & Reason for Allocation of Risk

• Fraser Jewellers (1982) Ltd v Dominion Electric Protection Co, [1997] OJ No 2359 (CA).

• Jewellery company contracted with ADT to obtain a security system with a monitoring component. The limitation clause stated:“It is understood that ADT is not an insurer… the amounts payable to ADT hereunder are based upon the value of the services and the scope of liability as herein set forth and are unrelated to the value of the customer’s property or property of others located in customer’s premises…. If ADT should be found liable for loss, damage or injury due to a failure of service or equipment in any respect, its liability shall be limited to a sum equal to 100% of the annual service charge or $10,000, whichever is less.”

• There was evidence that the plaintiff had not read the contract before signing

• Monitoring system failed to prevent a robbery

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Hope - Fraser Jewellers, cont’d

• Court enforced the limitation clause, holding that it was not unfair, unreasonable or unconscionable, and absent fraud or misrepresentation, contracts should be enforced

• Specific findings:

“ADT is not an insurer and its monitoring fee bears no relationship to the area risk… The alarm services were to be provided upon the value of the services and the scope of liability set out in the agreement… to make the security company liable… as an insurer… would be to fundamentally change the contract agreed to by the parties”

• The takeaways: disproportionate risk to reward and contractual indicia of that!

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Despair - Reluctance to Enforce Limitation Clauses

• Courts reluctant to enforce limitation clauses where the party relying on it is guilty of gross negligence

• Robet v Versus Brokerage Services Inc, [2001] OJ No 1341 (SCJ).

• Services offered through an electronic trading system resulted in trading losses to the customer

• Court found “complete failure of the defendant’s accounting system beyond any contemplated error or provision of restricted liability under the parties’ contractual agreement”

• Exclusion clauses are not to be interpreted so broadly as to indemnify a party from failing to provide the very thing contracted for

• Clause not enforced in this case – Court awarded $14,220 in direct damages

• Clause non-market

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Reluctance to Enforce Limitation Clauses

• Courts reluctant to enforce limitaiton clauses where the party relying on it is guilty of gross negligence

• Zhu v Merrill Lynch HSBC, [2002] BCJ No 2883 (BC Prov Ct)

• Like Robet, a case dealing with online trading• Exclusion clause not enforced because it virtually eliminated

liability for inaccuracy in the performance of services contracted for by the customer, and exonerated acts of gross negligence

• Court awarded full amount of direct damages claimed, $9,768• Retail vs enterprise cases

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Reluctance to Enforce Limitation Clauses

• Courts reluctant to enforce limitation clauses where not enough notice of it has been given

• Nor-Tec Electric Ltd v EJB Holdings Inc, [1998] MJ No 392 (Man QB).

• Court found that there was a fundamental breach of a contract for provision of computer services, but that the limitation of liability clause excluded the liability of the defendant and was not unconscionable

• However, the court declined to enforce the limitation of liability clause because there was insufficient notice of it given

• Court awarded damages totalling $9,819, including the cost of replacing required equipment, expenses paid to third party consultants in relation to the problems, and time lost by employees due to server “down time”

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Uncertainty: Enforcement

• To be effective, limitation of liability clauses must be clear and unambiguous

• Contra proferentum construction

• Courts may decline to enforce limitation of liability clauses because:

• Clause is unconscionable• Clause is unreasonable• Insufficient notice

• Trend exists of scrutinizing exclusion clauses more harshly than just limitation clauses.

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Uncertainty: Enforcement

• Typically, limitation of liability clauses in IT contracts:

• exclude liability for “special, consequential and indirect” damages

• limit the general damages recoverable to a specified amount (usually related to the price of the contract)

• Some limitation clauses attempt a broader exclusion of liability, to cover even general/direct damages

•The broader the clause the riskier it is

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Limitation of Liability Clauses - Enforcement

• In the IT sector it can be difficult to determine which damages are barred by the limitation of liability clause and which are not

• Among the challenges:

• Discerning the degree that a malfunction in the system constituted a significant breach of the agreement

• Discerning what damages flow naturally from a breach and what flow from special knowledge of the breaching party

• What are special damages

• Necessary to be able to categorize what category each head of damage falls under

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Tertiary Liability

• No cases addressing liability of third parties directly

• Generally, the common law approach is to find whether third parties owed a duty of care to the plaintiff, and if so whether the duty has been breached

•B & S Publications Inc v Hotzel, 2007 ABQB 222

• Did not involve a limitation of liability clause• Website provider selected Microsoft Access as its database

management system and TELUS as its web host. Both these tools appeared to have played a part in the malfunctioning of the website

• Plaintiffs asked the court to find that the defendants should have added TELUS as a third party. Court declined, because the plaintiffs had contracted directly with TELUS

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A Newer Twist – Duties of Good Faith

• Bhasin v Hrynew, 2014 SCC 71

• Supreme Court finds a contractual duty of good faith

• Extends to many contexts

• Long running multi-year contracts particularly susceptible

• Benefits and complications for both vendor and customer

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Hope: Risk Allocation Works

• Clear allocation clauses are enforced, especially at the enterprise level

• Sanofi Pasteur Ltd v UPS SCS Inc, 2015 ONCA 88

• UPS stored Sanofi medications pursuant to a contract that limited liability to $100,000 and required Sanofi to get insurance.

• UPS failed to control the temperature of the storage, rendering the medications unsaleable. Sanofi’s insurer sued UPS.

• Court held that the insurance clause meant that Sanofi assumed all risk of damage to the medications, except for $100,000. Court also held that the coverage was intended to extend to third party manufacturers and installers.

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Considerations for Drafters and Negotiators

• Cardinal rules of construction – starting point for meaning is the contract as a whole

• Direct and indirect evidence of deliberate risk allocation, and economic purpose

• Clarity on the purpose of the clause – “everybody knows what it meant”

• Informs:

• Acceptance of risk/margin at outset• Psychology of discussion when the contract is disrupted

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