Legal Briefing

Exclusion of liability: Court of Appeal holds ex-gratia payments are recoverable

The In-House Lawyer Logo

Corporate and commercial | 01 October 2010

An injured party is entitled to claim for damages in compensation for breach of contract by the guilty party, provided the damages are not too remote. The principle for the remoteness of damages was first laid down in Hadley & anor v Baxendale & ors [1854], and has stood as good law ever since.

Hadley defined the kind of damages that are recoverable as follows:

  1. damages arising naturally, ie according to the usual course of things, from the breach of contract itself; or
  2. damages that may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract as the probable result of the breach of it.

It is in this context that the recent first instance and Court of Appeal decisions in GB Gas Holdings Ltd v Accenture (UK) Ltd & ors [2010] are considered. The Court of Appeal upheld the High Court’s ruling that ex-gratia payments to customers (in this case compensating for poor customer service) fell within the first limb of Hadley. As such, they were not excluded under a contract between the parties, despite the inclusion of a clause excluding loss of profits, loss of revenues and any ‘indirect, consequential or punitive’ damages.

It should be noted that the point was dealt with as a preliminary issue. Therefore, the courts were not required to determine whether or not the items of loss claimed were actually recoverable on the facts of GB Gas.

FACTS

The parties entered into a contract whereby Accenture (UK) Ltd (Accenture) agreed to design, supply, install and maintain a new IT system for GB Gas Holdings Ltd (GB Gas), a gas and electricity company. The system included an automated billing system.

The contract contained numerous warranty provisions and provided that in the event of a breach of warranty by Accenture, Accenture would be obliged to make different levels of effort to remedy the defect, depending on whether the breach was a ‘fundamental defect’ or a ‘material defect’.

A ‘fundamental defect’ was defined in the contract as a fundamental breach of the warranty provisions during the warranty period, ‘which causes a severe adverse effect on the British Gas Business’; whereas a ‘material defect’ is defined to be a breach of the warranty provisions during the warranty period, ‘which has or is likely to have an adverse effect on the British Gas Business’.

By letter of 12 February 2007, GB Gas notified Accenture of certain alleged ‘fundamental defects’ in the billing system. In particular, increasing numbers of customer accounts went unbilled and customer satisfaction declined. As a result, customer service staff had to intervene manually in what should have been automated processes, creating a huge backlog of work.

Accenture refused to take any action, contending that it was under no legal obligation to do so because the defects were not ‘fundamental defects’ as defined under the contract.

GB Gas issued proceedings against Accenture, claiming damages under various heads, including £8m for ex-gratia compensation payments to customers, which it claimed were made to address reputational damage arising out of billing difficulties and perceived poor customer service as the result of Accenture’s breach.

Under the contract, liability for the following was excluded:

  1. loss of profits or of contracts arising directly or indirectly;
  2. loss of business or of revenues arising directly or indirectly;
  3. losses or damages to the extent that they are indirect or consequential or punitive.

A trial was ordered of numerous preliminary issues, including whether certain classes of loss claimed by GB Gas were excluded as consequential loss.

HIGH COURT DECISION

GB Gas argued that due to the alleged severe disruption to its new billing system, it suffered serious reputational damage, and as a result it paid £8m in compensation to its customers to reflect the billing difficulties and poor customer service they had received.

The judge at first instance held that ex-gratia payments to customers were recoverable as they were neither ‘indirect’ nor ‘consequential’ losses, but fell within the first limb of Hadley.

Field J found that one of the purposes of the new billing system was to improve customer relations and customer services, and it was clear from the context of the contract that Accenture assumed responsibility for losses in terms of compensation paid to customers, if the billing system failed to perform as it was intended.

COURT OF APPEAL

Accenture appealed against the judge’s decision on this (and all other) preliminary issues. It argued that the claim for ex-gratia payments to customers was, on a true analysis, a claim to recover the costs of mitigating losses flowing from Accenture’s alleged breach because GB Gas was concerned that it might lose several customers. The claim was therefore a claim for loss of revenue (such losses being expressly excluded under the contract).

GB Gas disagreed and submitted that the claim had always been pleaded as losses arising out of damage to GB’s good reputation suffered as a result of Accenture’s failure to comply with its obligations. Such losses, it said, were direct and therefore recoverable.

In considering GB Gas’ submission, the court noted that there might be difficulties in finding a strong legal basis to support a claim for reputational loss and as such it would have to look at the facts to determine whether or not Accenture had assumed responsibility for such losses. However, the court made it clear that the claim as pleaded by GB Gas for the recovery of ex-gratia payments was not a claim for loss of revenue or loss of profit, but rather was a claim for direct loss, which, assuming the claim was made out at trial, would be recoverable.

The court therefore held that the ex-gratia customer compensation fell within the first limb of Hadley and was not excluded by the contract’s exclusion clause.

CONCLUSION

Despite being a decision on a preliminary issue only, GB Gas provides some reassurance that when a contract is breached, the courts will endeavour to put the innocent party in the position they would have been in had the wrongdoer not breached the contract but performed it.

Although the courts were not requested to consider whether or not the ex-gratia payments to the customers were recoverable, GB Gas does show that the courts may recognise the recoverability of ex-gratia payments to customers, being direct losses falling within the first limb of Hadley.

For practitioners who are drafting exclusion of liability clauses this underlines the importance of being as precise as possible about the types of loss that will and will not be recoverable in conjunction with more general ‘catch all’ provisions.

Where possible, parties may be well advised to set out a list of foreseeable losses within their contract and agree on which of those losses are recoverable if things go wrong, and expressly exclude items of potential loss for which they do not intend to assume liability.