Case Study

CASE STUDY ST ALBANS CITY AND DISTRICT COUNCIL AND INTERNATIONAL COMPUTERS LIMITED - “ST ALBANS AND BEYOND”

Robert McCallough

Introduction The Court of Appeal has provided useful guidance as to the status of software and the implied terms that operate at law in respect of the supply of software. This guidance has been sought for sometime in the computer industry as there has been lengthy debate as to whether software is services or goods or something else.

The Court of Appeal’s decision is also of importance with regard to the question of the reasonableness of limitation clauses in written standard terms of business by reference to the criteria set out in the Unfair Contract Terms Act 1977 (UCTA). There are a number of important issues arising from this judgment but this article only concentrates on the issues relating to the status of software and the opera- tion of UCTA.

The facts This was an Appeal from the judgment of Mr Justice Scott Baker holding ICL liable in damages to St Albans in respect of the supply of defective software for the purpose of calculation and management of the Community Charge scheme. The relevant contract between the parties was signed on the 24 December 1988 with a delivery date in February 1990 although it was contemplated that the supply of early versions of the Community Charge software would begin earlier than February 1990 so as to allow St Albans to complete various preliminary steps such as the creation of a database for

the Community Charge register. With this in mind a number of different releases of the software were supplied to St Albans by ICL.

Mr Justice Scott Baker found that one such preliminary step was the establishment of an accurate count of the chargeable population. From 2 November 1989 St Albans were in- formed that the relevant count had to be returned to the Secretary of State not later than 8 December 1989. The software used for the purpose of the computation was defective with the result that the relevant population was over-stated by 2966. A new release of software which would have corrected the error was installed by ICL on 4 December 1989 but only after the incorrect figures had been extracted from the earlier release of software. Consequently St Albans made a return using the incorrect figures on 5 De- cember and the error was not discov- ered before the statutory deadline of 8 December 1989 after which date the amount of the precept payable by St Albans to the County Council could not be altered. St Albans set its Com- munity Charge on 28 February 1990 with the result that the Community Charge for 1990/1991 was calculated on the basis of an over-stated popula- tion. Accordingly, in 1990/1991 the individuals who were liable to pay the Community Charge underpaid by &484 000 and St Albans’ charge payers bore an additional precept of &685 000 (net various allowances). ICL relied upon a limitation clause in their standard terms of business limit- ing damages for such loss to &lo0 000.

The trial judge had awarded the sum of &l 314 846 to St Albans as he found that the limitation clause was unrea- sonable by reference to the criteria in UCTA and in particular was influenced by the insurance cover available to ICL which is one of the criteria set out in UCTA.

The Court of Appeal Judgment Findings The Court of Appeal made a number of findings, the most important of which are as follows: 1.

2.

3.

4.

ICL, by the terms of the contract, agreed to provide software to meet all the requirements of St Albans in respect of the Community Charge regime whatever this may be and whenever required.

At the point of delivery of the software by ICL to St Albans it had to be fit for its purpose (i.e. capable of calculating the relevant population) irrespective of the fact that the software was delivered before the strict contractual deliv- ery date.

Although a supplier’s written terms of business may have been the subject of pre-contractual negotia- tion, if these standard terms are incorporated into the contract without amendment, then the par- ties are still ‘dealing’ on these terms for the purpose of Section 3 of UCTA and the terms are subject to the reasonableness test.

The trial judge’s view as to the

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Case Study

limitation clause being unreason- able would not be interfered with by the Court of Appeal. In accor- dance with the principle in George Mitchell (Chesterhall) Ltd. v Finney Lock Seeds Ltd [1983] 2 AC 803 an Appellate Court will only interfere with the findings of the trial Judge as to reasonableness if the Judge had proceeded on some erroneous principle of law or if he was plainly and obviously wrong. It was not the case that Mr Justice Scott Baker had acted upon some erro- neous principle or that he was plainly and obviously wrong.

Judicial opinion Sir Iain Glidewell gave his opinion as to the circumstances in which implied terms will operate in relation to the supply of software to which Lord Justice Nourse and Lord Justice Hirst agreed. Where a software program is embodied in a physical medium such as a floppy disk or supplied as pre- installed software on a computer sys- tem, then terms will be Implied (as to satisfactory quality and fitness for purpose) by the Sale of Goods Act 1979 or by the Supply of Goods and Services Act 1982. However, the pro- gram itself is not goods within the statutory definition and in circum- stances where, pursuant to a contract, there is a transfer of program without sale or hire - as in St Albans by the program being loaded onto a custo- mer’s computer - then the implied terms as to quality or fitness for purpose will not operate under statute. However in accordance with the case of Trollope 81 Colls Ltd v N.W. Metropolitan Regional Hospital Board [1973]1 WLR 601 in the ab- sence of any express term as to quality or fitness for purpose or any term to the contrary then the contract will be subject to an implied term that the program be reasonably fit for its intended purpose.

St Albans and beyond It has been standard Industry practice in software development contracts for software developers and customer users to work together on the software to identify errors or bugs which can then be eradicated or dealt with in some alternative way. Once the soft-

ware has been tested and installed on the customer’s system, it is not unusual for a limited number of bugs to still be found as users become more confident and look to use the more complex functions. Small teething problems are almost par for the course in complex development software, hence suppliers of such software offer on-site support services and maintenance programmes, so that, soon after installation, all bugs are removed.

Against this background ICL deliv- ered releases of software to St AIbans before the strict contractual delivery date to assist the Council. The effect of the Court of Appeal Judgment is that when such software is delivered it must be bug free so as to be fit for its intended purpose. On the face of it, this is In conflict with the case of Saphena Computing Limited v Al- lied Collection Agencies Limited [1995] 51 FSR 616 where Staughton LJ said in the Court of Appeal that:

“even programs that are reasonably fit for their purpose may contain bugs”

The two authorities are reconciled on the basis that bugs may exist in a program but not to the extent that it makes the program unfit for its pur- pose. This would involve both a quali- tative and quantitative assessment of the actual errors in the program by reference to the particular purpose that was intended.

Suppliers of developed software will no doubt change their practices in the future and have a far more rigid view on the question of supply of releases of software in the develop- ment cycle. If releases are supplied before the strict contractual date sup- pliers may require the customer to acknowledge that the software con- tains bugs and may not be fit for its purpose and that if the customer so uses or relies upon that software at that stage then he will be doing so at his own risk. However, in itself such a provision used by suppliers will no doubt be subject to the reasonableness test imposed by UCTA. It seems that few suppliers are likely now to be willing to assist customers by deliver- ing software before the contractual date. It is probably the case that suppliers will seek to negotiate longer development periods in order to en- sure that software is bug free prior to delivery. A consequence of this is that the cost of developing software is likely to rise to reflect the developers in-

creased overhead in the prolonged development period.

There may well be ingenious at- tempts to avoid programs being re- garded as goods thereby avoiding the implied terms under statute. Clearly in a development scenario suppliers will ensure that the software is simply installed pursuant to licence. However, it may well be that suppliers of package software will seek payment for soft- ware by way of licensing arrangements but the implied term at common law mentioned in Trollope % Colls will operate as to fitness for purpose. If such licensing arrangements avoid the statutory terms being implied suppliers still need to overcome the hurdle of establishing the terms are reasonable under UCTA in particular any exclu- sion of the common law implied term.

In this regard Schedule 1,1(i) of UCTA may help as it specifically excludes contracts as far as they relate to the creation or transfer of a right or interest in, inter alia, copyright techni- cal and commercial information or other intellectual property. It is an open question as to whether such a licensing arrangement will be success- ful in avoiding the implied terms under statute and the reasonableness test under UCTA.

It is now clear that negotiation as to suppliers’ standard written terms of business is not sufficient in itself to avoid the reasonableness test under UCTA. If the standard terms need to be altered in some way, what degree of alteration is required? This also may be a qualitative and quantitative test. No guidance has been given by the Court of Appeal as to the approach that may be adopted. As for limitation clauses will it be sufficient merely to increase the amount of damages recoverable under the standard limitation clauses? Do the entirety of the terms need to be altered or may one look at alteration on a clause by clause basis? The only guidance that can be derived at this stage is the slightly unhelpful point that each case will be judged on its parti- cular facts.

To avoid limitation clauses being the subject of the reasonableness test under UCTA it is of course open to suppliers to scratch draft each contract but this is just not practical in the commercial world. Large suppliers of software enter into thousands of con- tracts each year and it would be a total

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nonsense to suggest that they should operate without some form of standard terms of business. The more realistic approach appears to be to accept that clauses will be subject to the reason- ableness test but aim to ensure that they will pass the test! Some sugges- tions as to approaches that may be adopted are: 1. Negotiate and scratch draft con-

tracts over a certain threshold in terms of contract price.

2. By arrangement with indemnity insurers set the limitation clause to a level which coincides with the amount insurers will pay under the

policy for the particular loss suf- fered.

3. Operate limitation clauses by a reference to a price risk ratio. The contract price may be ad- justed to reflect the level of da- mages a customer wishes to recover under the limitation clause.

4. Limitation of damages expressed as a percentage of the contract price such as 125% of the contract price.

Incidentally, both before the trial judge and the Court of Appeal it was argued on behalf of ICL, that loss

suffered by St Albans was consequen- tial loss and, as such, excluded under the contract. This argument was not dealt with specifically by the trial judge or the Court of Appeal but by inference was considered to be direct loss rather than consequential loss. However this point in itself is highly debatable.

Robert McCallough, Solicitor, Masons, 30 Aylesbury Street, London EClR OER Tel: +44 (0)171 490 4000 Fax: +44 (0)171 490 2545 E-mail: Info@masons.com

BOOK REVIEW Telecommunications Universal Service ObIigations in a Competitive Telecommunications Environment, 1995, soft-cover, OECD, ICCP Series NO 38, 152 pp., ISBN 9264 146 644.

This report, published within the Information Computer Communication Policy Series of the Organization for Economic Cooperation and Development, examines the issues associated with the liberalization of telecommunication service markets. It focuses the attention of policy makers on whether universal service objectives can be met in a competitive environment. It is less concerned with debating the appropriateness of universal service and other non- commercial objectives, but rather with the process and procedure for achieving those objectives where deemed appropriate in a cost effective way. It points out that recent rapid changes in telecommunication technology and policy have liberalized markets in an increasing number of countries. This has given rise to concerns about the sustainability of universal service policies based on cross-subsidisation. This has contributed, says the report, “to the widespread belief that the tide of deregulatory change permitting rapidly increasing competition poses a significant threat to universal service. Moreover, this argument has been exploited by public operators as a means of preserving their monopoly position. In some countries, this concern over the threat to universal service is a central factor impeding market liberalization to permit competition.”

The report demonstrates that there are various ways of addressing these problems using mechanisms that are more cost effective than cross-subsidisation, so that pursuit of universal service objectives can be maintained in a competitive environment.

The study concludes that competition and the achievement of universal service objectives are therefore not mutually exclusive nor necessarily in conflict. With appropriate arrangements in place, competition, rather than monopoly, will be the more appropriate structure to ensure the maintenance - or expansion - of universal service objectives and targets. ‘What this suggests is that rather than find expression in attempts to impede competition, the concern of a universal service could be more constructively harnessed and directed towards the design and installation of such appropriate arrangements as are necessary for the preservation of universal service in a competitive environment.”

Available from: OECD, 2 rue Andre Pascal, 75775 Paris Cedex 16, tel: +(33-l) 45248200. Internet: compte.PUBSINQ@oecd.org.

48 Computer Law & Security Report Vol. 13 no. 1 1997 01997, Elsevier Science Ltd.