The In-House Lawyer

Kingsway Hall Hotel Ltd v Red Sky IT (Hounslow) Ltd [2010] examines the use and enforceability of exclusion clauses in a contract for the provision of software and related services. In the wake of BSkyB Ltd & anor v HP Enterprise Services UK Ltd & anor (Rev 1) [2010], it provides further salutary lessons for IT suppliers on the proper management of their sales and contracting processes. Under the Unfair Contract Terms Act (UCTA) 1977, certain exclusions and limitations of liability are either unenforceable or subject to a test of reasonableness.

Facts

Kingsway operates the Kingsway Hall Hotel, a four-star, 170-bed hotel, located in Covent Garden. Red Sky supplies IT systems and services to the hotel trade, including back office reservations and point of sale systems, and a front office software system known as ‘Entirety’. Following a series of demonstrations, including one of a ‘live’ Entirety system in use at The East India Club, and submission of a proposal expressed to be ‘subject to contract and Red Sky IT’s standard terms and conditions of trade’, Kingsway agreed to buy an Entirety system from Red Sky. Except around pricing, there were apparently no other specific discussions concerning the terms of the contract. Kingsway maintained that it relied on Red Sky’s advice in respect of the usability and functionality of Entirety when making the decision to buy. Also key to the factual matrix, were Red Sky’s claims in its advertising and marketing of the product, that use of Entirety would give increased revenue and occupancy levels, improved guest service, faster check-in and better forecasting information.

Following go-live in October 2006, the system was plagued with a series of faults, particularly in relation to the accurate calculation of room availability and group bookings, resulting in disruption to hotel operations. Despite repeated requests from Kingsway to resolve the problems over a period of several months, Red Sky failed to do so to Kingsway’s satisfaction. Kingsway subsequently rejected Entirety and implemented a replacement system, alleging that Entirety was neither of satisfactory quality nor fit for purpose. Kingsway also claimed damages, including:

1. lost profits due to reduced occupancy and damage to business reputation impacting customer bookings;
2. cost of the replacement system; and
3. additional and wasted staff costs associated with addressing the problems caused by Entirety.

In defending the claims, Red Sky sought to rely on its standard terms and conditions, which comprised part of the contract between the parties. HHJ Toulmin summarises certain relevant provisions from these standard terms as follows:

1. clause 10.1 excluded all terms as to performance, quality and fitness for purpose, except as provided in clause 10.2;
2. clause 10.2 contained an express warranty that ‘the programs will in all material respects provide the facilities and functions set out in the operating documents’;
3. operating documents were defined in clause 1.1.6 to include ‘any operating documents supplied by the defendant to the claimant’;
4. clause 10.4 provided that the sole remedy for breach of the warranty in clause 10.2 was the maintenance and support cover;
5. clause 10.7 provided that clause 10, together with clause 18, stated the entire liability of the defendant in respect of any fault or error in the IT system; and
6. clause 18 contained limitations and exclusions of liability as follows –
7. clause 18.3.2 excluded liability for any indirect or consequential loss, and expressly excluded loss of profits and similar losses; and
8. clause 18.3.3 limited liability for direct loss to four times the total price (agreed to be £70,463).

Red Sky argued that clause 10.1 and clause 10.2 applied to exclude the terms as to satisfactory quality and fitness for purpose implied by the Sale of Goods Act 1979 and the Supply of Goods and Services Act 1982, and, further, that the limits and exclusions of liability at clause 10.7 and clause 18 would apply. While accepting that s3 of UCTA 1977 applied, Red Sky argued that the exclusions satisfied the reasonableness test required by that section, claiming:

1. the parties were of equal bargaining power relative to each other, not least because there were over 30 property management systems available in this highly competitive market;
2. the customer received an inducement to agree to the terms, in that a significant discount was given and concessions were made on payment terms, despite the fact that the contract price was very modest;
3. there was a long course of dealing between the parties so that Kingsway ought to have become aware of the existence of, and the extent of, the terms and that clause 18.3 contained a prominent warning; and
4. this was not bespoke software (although it was configured for the customer) and, as Entirety was used by a wide range of customers, the consequences of a breach would differ widely depending on which customers were using the software.

Red Sky also sought to rely on the judgment in Watford Electronics Ltd v Sanderson CFL Ltd [2001], in which the judge stated that where experienced business people, representing substantial companies of equal bargaining power, negotiate an agreement, they may be taken to have had regard to the matters known to them, and to be the best judges of the commercial fairness and reasonableness of the terms of the agreement that they have reached.

Kingsway counter-argued that the exclusion clauses did not apply because clause 10.2 only applies where the operating documents have been supplied and that no such documents were provided at the time Entirety was installed. Further, it argued that if clause 10.2 did apply to exclude the statutory implied terms as to quality and fitness for purpose, it would be unreasonable under s11 of UCTA 1977.

Judgment

HHJ Toulmin held that UCTA 1977 applied to the contract and that the test of reasonableness had not been satisfied, concluding that:

1. the parties were not of equal bargaining power;
2. although Kingsway and Red Sky had negotiated on price, Kingsway did not receive any inducement to agree to Red Sky’s standard terms;
3. it was not correct that there was a long course of dealing between the parties, such that Kingsway ought to have known the existence of and the extent of the terms; and
4. Entirety was not bespoke software.

Red Sky’s contract assumes that its software is sold ‘off-the-shelf’, as opposed to being bespoke, and also that through access to the operating documents and attendance at demonstrations, customers would be able to decide whether the software would meet its requirements. HHJ Toulmin concluded that:

‘Operating documents must be construed as being those documents to be supplied by Red Sky… which would enable a customer in advance of signing the contract to understand fully the system being offered for sale, including the functionality and sophistication of the system.’

In the judge’s view, this had not happened. The contract also assumes that the customer will decide itself whether or not to proceed with the purchase, but Kingsway had relied on Red Sky’s positive recommendation that the software was suitable for Kingsway’s purposes and that Kingsway was induced to make the purchase by the representations made by Red Sky personnel.

HHJ Toulmin found that as the operating documents had not been provided, clause 10.2 and the exclusions derived from it did not apply. As a result, the statutory implied terms as to satisfactory quality and fitness for purpose applied, despite Red Sky’s attempts to exclude them, and Kingsway was entitled, having given Red Sky every opportunity to fix the reported defects, to reject Entirety. He added that even if the exclusion prescribed under clause 10.2 did apply, as Red Sky’s employees were aware of certain essential requirements of Kingsway, it would fail the reasonableness test having regard to the circumstances that were or reasonably ought to have been known to Red Sky or Kingsway, or be in the contemplation of the parties when the contract was made (and, therefore, the statutory implied terms would again form part of the contract).

HHJ Toulmin commented that it might be reasonable for a supplier to exclude implied terms where a customer has the means to satisfy itself as to the quality and fitness for purpose of the product, and does not rely on the supplier’s advice. He also noted that the contract, being on Red Sky’s standard terms and, apart from price, not negotiated, was very different from that contemplated in Watford Electronics.

Comment

Kingsway provides a useful reminder of the principles that will be considered when a challenge is made on the basis of UCTA 1977. More importantly, however, it serves as a warning to IT suppliers to ensure that, when using standard terms, sales and contracting processes, and the terms themselves, are suitable for the subject matter of the contract. Standard terms should be reviewed on a regular basis and where they don’t reflect practice they should be tailored as appropriate. Equally, supplier sales teams need to be properly schooled in how to conduct themselves during the sales and contracting process. Failure to do so, as Kingsway shows, may result in fundamental contractual protections being undermined or even invalidated altogether.

By Andrew Shindler, partner, and Andrew Sutherland, associate, SJ Berwin LLP.

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