ST ALBANS CITY & DISTRICT COUNCIL v INTERNATIONAL COMPUTERS LTD, HIGH COURT, SCOTT BAKER J., 3RD OCTOBER 1994

INTRODUCTION Liability for loss sustained as a result of errors in software has been the source of much speculation. Uncertainty has arisen because of doubts about the nature of software contracts and the applicability of the Unfair Contract Terms Act 1977. The case of The Salvage Association v CAP Financial Services Ltd (1992) High Court, Official Referee [reported in (1994) 10 CLSR 2061 was very instruc- tive in classifying a contract for develop- ing and installing software as a service contract regulated by the Supply of Goods and Services Act 1982 and showing that the Unfair Contract Terms Act 1977 can apply to software con- tracts. However, that case was con- cerned primarily with the failure of a software developer to deliver software of a satisfactory quality. The present case is important in that it deals with the situation where a software ‘bug’ caused financial loss to the client and it has far reaching implications for software devel- opers, many of whom would be advised to review their standard term contracts and level of insurance cover. The decision also includes an important discussion of the principles to apply in assessing damages where the plaintiff already has recouped his loss from elsewhere.

FACTS The plaintiff, a local authority, was responsible for setting the level of and collecting the community charge (other- wise known as the ‘poll tax’) which came into effect on 1 April 1990. It decided to invite tenders for the supply of suitable hardware and software for keeping a register of charge payers and to carry out additional functions such as raising the necessary bills. The contract was awarded to the defendant in 1988 and an initial registration system (IRS) was supplied by the defendant in February 1989. Its purpose was to allow basic information about charge payers to be entered into a database. Later more sophisticated software, known as COM- CIS, was delivered on 30 October 1989, a number of further releases of which

were delivered subsequently. The Secre- tary of State required local authorities to make returns of their population sizes by 8 December 1989 and the plaintiff using the COMCIS software to extract the population figures for its area, returned a total population figure which was too high by 2966. This error was caused by a bug in the software. The implications of using a figure that was an overestimate were primarily two- fold. It meant that the local authority’s income was insufficient (because it set the community charge too low and grants from the Secretary of State were, accordingly, also too low) and, secondly, the local authority’s expendi- ture was greater than it should have been in terms of payments to the precepting authority (the county coun- cil) and contributions to the ‘safety net’. The total loss suffered amounted to f 1 314 846 including a figure for loss of interest. The fact that the population figure might be incorrect was not discovered until 26 February 1990 when a later release of the software was used to create a printout of the population figures. By this time it was far too late to adjust the community charge, precept or grants as, once fixed, the charge could not be altered and the Secretary of State did not allow changes to be made to population figures previously submitted. The contract was made on the defen- dant’s standard written terms. During preliminary negotiations, the plaintiff expressed concern at some of the terms, particularly that limiting the defendant’s liability to f 100 000. How- ever, the defendant, knowing that the plaintiff was under tremendous time pressure, said that the contract must be signed within a few days otherwise some of the hardware required for the contract could not be reserved for the plaintiff and would be used elsewhere. Thus, although some points remained under discussion, the defendant’s stan- dard written contract remained un- touched.

DECISION Scott Baker J. accepted counsel for the

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plaintiff’s submission that the defendant was under an obligation to provide software that would maintain a reliable database of names entered onto the community charge register, accurately count those\ names and accurately retrieve and display the population’s count. Furthermore, the software had to be reasonably fit for its purpose of maintaining and retrieving a reliable register. There was nothing in the contract to modify those obligations. The judge considered that there was a plain breach of contract because of the erroneous figures produced by the soft- ware. Additionally, an assurance made by the defendant’s project manager that the figures could be relied upon was a breach of the project manager’s contract of service which was part of the overall agreement. This was a negligent mis- representation and the project man- ager’s obligations were not, as required, exercised with due diligence. A term in the contract that errors had to be notified to the defendant within three months was of no effect because the plaintiff was unaware of the error and had no way of discovering it. The judge, in awarding the plaintiff the full amount claimed, said that the plaintiff was not at fault in failing to discover the error nor in failing to take different action when it became appar- ent that there was a problem with the software. He was of the opinion that the defendant had failed to establish that the limitation clauses in the main agreement and the service agreement incorporated in it were reasonable in the circumstances. The important aspects of the judgement are explored in more depth below.

NATURE OF CONTRACT The defendant argued that the contract fell outside the provisions of both the Sale of Goods Act 1979 and the Supply of Goods and Services Act 1982. Scott Baker J. considered that software is goods within the Sale of Goods Act remarking that, otherwise, it would be difficult to see what it could be. He discussed the Australian case of Toby

Constructions Products Ltd v Compu- ta Bar (Sales) Pty Ltd, [I 9831 2 NSWLR 48 where it was held that a contract for the supply of hardware and software was a sale of goods contract, although the question of whether soft- ware alone is goods was not decided. However, the question of whether soft- ware is goods did not have to be determined in the present case because all the relevant obligations were con- tained in the contract itself. Whilst remarking that software is classed as goods for the purposes of Value Added Tax and classed as plant and machinery for the purposes of section 67A of the Capital Allowance Act 1990, the judge’s brief reference to copyright showed a lack of understanding. He said that software is a literary work by virtue of the Copyright, Designs and Patents Act 1988 “in the same way as a book”. It is not the book which is the subject matter of copyright but the literary work that is expressed on the pages of the book. The purchase of a book is a sale of goods contract but the goods comprise only the paper pages, cover, binding and printer’s ink. There is no transfer of the property in the literary work itself and section l(1) of the Sale of Goods Act 1979 requires a transfer in property in goods. If the sale of a copy of a literary work is governed entirely by the Sale of Goods Act, a purcilaser of a novel that was badly written or had a disappointing dPnouement would be able to sue for breach of condition (merchantable qual- ity). No-one has ever suggested that is the law. Why should a copy of a computer program be treated differ- ently? The judge also said that, if software fell outside the provisions of the Sale of Goods Act 1979, the recipient of soft- ware would be left without protection, This is not so. Where software is specifically written at a client’s request, the contract is, essentially, a service contract governed by the relevant provi- sions in the Supply of Goods and Services Act 1982, especially the implied term of reasonable care and skill contained in section 13. Even without this statutory term, the courts could imply an equivalent term based on common law. Additionally, the law of negligence could be applicable and, in particular, the law relating to negligent

misstatement.

DAMAGES - WHETHER PAYABLE The defendant argued that the loss was not a plaintiff’s loss. However, Scott Baker J. likened the plaintiff’s situation to that of a trustee and that it had a duty to recover losses for the benefit of a its citizens as a whole. Another question was whether the plaintiff had suffered any loss as a result of the error in the software as it was able to recoup the shortfall from the charge payers the following year by increasing the charge accordingly. Indeed, this is what the plaintiff did. The defendant argued that the loss was, at law, irrecoverable. The judge rightly pointed out that this is essentially what happens where a loss is insured against. The fact that the loss is made good by a third party does not mean that it is not recoverable against the party that occasioned the loss, although with insurance there is a duty to repay the damages received to the insurer. The question of whether a benefit from a third party should be taken into account when assessing damages occa- sioned by a breach of contract was considered by the judge who said that there had been difficulties in the past in determining the principle to apply in ‘benefit’ cases. After reviewing a num- ber of authorities, he cited with approval the judgement of Staughton L.J. in Linden Gardens Trust v Lenesta Sludge Disposals Ltd [I9921 57 BLR 66 where he said that the general principle that damages are still recover- able where the loss has been made good by insurance, benevolence or govern- ment grants was not limited to these cases. However, the scope of the principle was difficult to ascertain though, in the subsequent appeal to the House of Lords (reported in [I9931 3 WLR 408) Lord Griffiths said that the law regards payment of another for the work necessary as a result of a breach of contract as a matter raised inter alias acta as far as the defendant is con- cerned. Scott Baker J. thought that the cate- gories of cases in which compensation derived from third parties was regarded by the law as irrelevant, was not closed. He considered that the benefit, being

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taxation that is required to be levied by statute, should not be taken into account. He remarked that it would offend commonsense if the defendants could escape liability in such a fortuitous manner and that the damages awarded would ultimately benefit charge payers who would pay a lower amount in future or be provided with improved services as a result. Thus, the judge held that the plaintiff had suffered a recover- able loss; an important point to note where software is being paid for indirectly, for example, by means of a government grant.

LIMITATION CLAUSE By section 3 of the Unfair Contract Terms Act 1977, where one party deals as consumer or on the other’s written standard terms of business, the other cannot, by reference to any contract term, exclude or restrict any liability for his own breach of contract except in so far as the term satisfies the requirement of reasonableness. The plaintiff was not dealing as consumer but the judge held that the contract was based on the written standard terms of the defendant even though there had been some negotiation between the parties. He said that it was not necessary for all the terms to have been fixed in advance by the supplier for the contract to be deemed to be the basis of written standard terms. Some terms, such as those dealing with quality or price, would often be the result of negotiation but that did not necessarily take the contract out of the reach of section 3. In any case, the judge held that either section 6 or 7 of the Unfair Contract Terms Act 1977 applied also. These sections deal with implied terms in contracts of sale or hire purchase of goods and other contracts under which the title to goods pass and also require that the reasonableness test be satisfied in relation to terms excluding or restrict- ing liability. Scott Baker J. then turned to section 11 of the Unfair Contract Terms Act 1977 and to Schedule 2 to the Act for the reasonableness test, pointing out that the burden of proof lies with the person seeking to rely on the relevant terms. Following Potter J. in The Flamar Pride [I9901 Lloyds Rep 434, Scott Baker J. accepted that it was reasonable to use

Schedule 2 in relation to section 3 although the Act does not expressly state that Schedule 2 is so applicable. In terms of applying the test of reason- ableness, the judge adopted the ap- proach suggested by Lord Griffiths in Smith v Bush [I9901 1 AC 831 (as did Judge Thayne Forbes The Salvage Association v CAP Financial Services Ltd) being that certain factors should always be considered such as the bargaining power of the parties, whether it was reasonably practicable to use an alternative source, the diffi- culty of the task to be undertaken and, particularly, the practical consequences of the decision. On this last point, the judge in the present case considered that it would be better for the loss to fall on a large international computer company (which was well able to insure itself against such claims) rather than falling on a local authority. Other factors of particular note were the resources of the defendant and its insurance cover amounting to f50 million. The judge decided that the plaintiff was in a slightly weaker bargaining position than the defendant and, although the plaintiff knew of the term (indeed, it had complained about its presence in the contract), had received no inducement, and was unable to enter into a similar contract with another without such a term, the defendant had failed to discharge its burden of establishing that the term was fair and reasonable in the circumstances.

COMMENT It is understandable that the plaintiff relied on the defendant, a major inter- national computer company, to provide reliable software and it is surprising that,

given the importance of arriving at an accurate population figure (the error was in the order of 3%), a method of double- checking was not incorporated into the software. Nevertheless, in view of the fact that software usually contains bugs, especially during its development, the plaintiff can be criticized for taking the figures at face value and without having a method of verifying the overall population, for example, by sampling. The fact that a printout produced five days before the deadline for submission to the Secretary of State contained a series of zeros should have been taken far more seriously by both parties. But for an assurance from the defendant’s project manager, the issue of liability might have been decided differently. The question of the nature of software contracts was considered by the judge but he was unable to provide a convin- cing answer, although, in the event, he could decide the case without doing so. Nevertheless, this case reinforces the view expressed in the Salvage Associa- tion case that the full brunt of the Unfair Contract Terms Act will be brought to bear on contracts involving the provision of software. As a matter of urgency, software companies should review their standard form contracts and insurance provision or be prepared to negotiate terms and conditions rather than insist- ing on their standard term contracts. The case is also very instructive as regards the difficulty that a software company may have in convincing a judge that any term excluding or limiting liability for defective software is reason- able. Here, the defendant’s term was deemed to be unreasonable even thought the plaintiff was aware of the term, other software companies had

BOOKREVIEW

comparable terms and the software was in use whilst still under develop- ment. However, the judge’s view that the plaintiff was in a weaker bargaining position can be criticized. It was a local authority responsible for a population in excess of 100 000 persons, employing professional staff and making use of a respected firm of management consul- tants to advise on the tender process. The plaintiff would certainly be in a stronger bargaining position than most small and medium commercial enter- prises dealing with a major computer company. Nevertheless, there are impor- tant lessons for computer software companies contained in the judgement. The case leaves a number of other liability issues unanswered. In particular, the question of liability for defective software outside the realms of con- tract, where the law of tort may pay a significant part, remains to be deter- mined. However, this may be addressed in the near future as there have been a number of instances where loss and even death or personal injury may have been attributable to defective software. The failure of the London Ambulance Service’s computer and the incorrect doses of radiation treatment given to cancer patients at a Staffordshire hospi- tal are just two examples that may provide the basis for some important and overdue precedents. If the Unfair Contract Terms Act applies to exclusion clauses, they must meet their responsi- bilities head on, and at the very least, provide sufficient insurance cover to compensate their clients and others likely to suffer loss for their software errors. David Bainbridge Report Correspondent

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