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Wasted expenditure: a loophole to exclusion of loss of profits?

The TCC’s recent decision in The Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Limited demonstrates how claimants can, in certain circumstances, claim their wasted expenditure in a way that gets around contractual exclusion of liability clauses.

The case concerns an IT outsourcing contract under which ATOS was to provide the Trust with a health record scanning and related electronic document management services, including an electronic medical records system (EMR System). The Trust became unhappy with the EMR System and terminated the contract for material breach.

The exclusion clause

The Trust claimed £7.9 million in wasted costs allegedly incurred in reliance on ATOS providing a contractually satisfactory EMR System. This included procurement and re-tendering costs, associated costs of hardware and software relating to the project and so on. ATOS sought to avoid liability by relying on the contract’s fairly typical exclusions of liability, including an exclusion of liability for:

“loss of profits, or of business, or of revenue, or of goodwill, or of anticipated savings; and/or indirect or consequential loss or damage…”

together with a general cap on liability.

In this preliminary issue hearing the TCC considered the liability cap, construing it as limiting the Trust’s right to recover damages. However, arguably the more interesting question was whether the Trust’s wasted expenditure was recoverable, or whether it was a loss of a type which was expressly excluded under the contract, namely loss of profit?

In evaluating this question, it is important to revisit the basis for calculating damages for breach of contract. As every law school student knows, contractual damages are compensatory in nature (in other words, they reflect the amount of the loss or injury suffered as a result of the breach). They should reflect the value of the contractual bargain that the innocent party has been deprived of as a result of the breach.

Expectation v reliance damages

Normally, this value is calculated on an “expectation basis” – the additional amount of money the claimant would require to achieve the benefit of the contract had it been properly performed. Alternatively, the claimant can claim its losses by reference to expenditure incurred in reliance on the defendant’s promise, such as sums paid to the defendant or other wasted costs (the “reliance basis”).

The court applies the (rebuttable) presumption that the value/benefit of the contract would at least equal the amount of the costs incurred by the claimant in reliance on the contract being properly performed. The reliance basis is nothing new, but claimants typically only rely on it where the expectation basis is difficult to quantify. Claimants may choose one basis or another, but not both.

The Trust claimed its damages on the reliance basis, asserting that its wasted expenditure was a loss occasioned by ATOS’s defective EMR System, as opposed to being loss of profits. The Trust had to prove some direct non-financial benefits to the contract, in order to characterise the wasted expenditure as representing something other than lost profits.

In her judgment, O’Farrell J acknowledged that this was the rare sort of case that involved a contract accruing non-financial benefits; the benefit to the Trust was the use of a functioning EMR System to deliver patient care, not any associated financial savings. The court therefore concluded that the wasted expenditure was a recoverable loss arising from the breach, which was not excluded by the exclusion clause.

At first glance, it might look like claimants are being given a back door to recover their loss of profits by using the reliance basis to calculate damages rather than the expectation basis. However, in reality the judgment is likely to be of limited application to commercial claimants.

What about split claims and the burden of proof?

Undoubtedly the nature of the Trust and its objectives made it easier for the court in this case to determine that the benefit of the contract was not financial. Most commercial organisations enter into contracts with the aim of making a profit, but could there be split claims? What if a commercial organisation claimed that the anticipated value/benefit of a contract was, at least in part, non-pecuniary, and similarly, what if an organisation like the Trust entered into a contract partly with the intention of making a profit?

This is an interesting case where the judgment on these preliminary issues probably gives rise to as many questions as answers, for example in relation to the burden of proof. The burden of proof in respect of wasted expenditure lies with the defendant to show that the wasted expenditure incurred actually exceeded the benefit of the contract. In a non-profit making contract, how does the defendant demonstrate that the (non-pecuniary) value of the contract exceeded the amount of the expenditure? In a claim partly for wasted expenditure and partly for loss of profit, the burden of proof would be on the defendant for one part of the claim and on the claimant for the remainder, which seems unsatisfactory.

Given the sums involved, it is possible that these issues will be explored on appeal. Until then, contract drafters will need to bear in mind that in those cases where the contractual benefit is not purely financial, standard contractual loss of profits exclusion clauses, which are a common feature of construction contracts, may not have their intended effect.

Berwin Leighton Paisner LLP Helen Armstrong

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