Drafting issues: unfair contract terms - the latest developments

Latest Developments on Unfair Contract Terms

The law in this area in relation to business to business transactions is currently largely covered by the Unfair Contract Terms Act 1977. Recent case law has generally shown a bias in favour of finding that the contested limitation of liability clauses were unreasonable and should be struck out on this basis. The decisions in St Albans City and District Council –v- ICL Computers Limited [1996] 4 All ER 481 and British Sugar PLC –v- NEI Power Projects Ltd [1998] ITCCR 125 illustrates this bias in favour of the customer.

There has also been another fairly recent case called Horace Holman Group Ltd –v- Sherwood Ltd which although currently unreported and decided on preliminary issues has followed this general customer friendly approach. This was a fairly typical IT dispute where Holman needed a new IT system and Sherwood were engaged to provide the system. Sherwood tendered for the system and, as they were apparently the market leader, they won the pitch and concluded the contract which was based on their standard terms. Unsurprisingly, the contract included the usual sort of exclusion of liability clause for all "special, indirect and consequential loss or for loss of contracts, goodwill, revenue, profits anticipated savings or other benefits and also limited liability for all damages to the value of the licence fee paid to them". There was apparently some negotiation of some of the terms of the contract although Holman had assumed that the limitation of liability clause was "non-negotiable" and had not raised it as a point in the negotiations. Notwithstanding that the clause that Sherwood was attempting to rely upon might appear to be an industry standard approach and comparable with what Homan may have obtained from other suppliers the judge did not uphold this provision as being reasonable. The judge concluded that the clause was unenforceable and should therefore be struck out.

On the basis of this decision and the other customer friendly cases I referred to above it would appear that suppliers had good cause to be concerned about how they might best limit their liability under their standard form contracts.

The case of Watford Electronics Limited –v- Sanderson CFL Limited [2001] EWCA 317 appears to have changed this customer friendly approach adopted by the courts in relation to limitation or exclusion of liability clauses. The decision of the Holman case was not applied as the court felt that the parties were of equal bargaining power and the Judge in this case expressed an unwillingness to find that experienced business men conducting negotiations had not been able to negotiate a fair and reasonable limitation of liability clause. Some of the judicial comments in this case would appear to suggest (if they are to be followed) that a court of first instance would not generally be able to find that a clause is unreasonable in a business to business contract. Chadwick LJ said that experienced businessmen … "should be taken to be the best judge on the question of whether the terms of the agreement are reasonable. The court should not assume that either is likely to commit his company to an agreement which he thinks is unfair, or which he thinks includes unreasonable terms."

Sam –v- Hedley

I would like to turn to this recent case which to some extent continues the correction of the previous customer friendly approach adopted by the courts in recent years. Hedley's was a small firm of stockbrokers and the claimant Sam was a small supplier of a software product called InterSet, that they claimed would be very useful for Hedley's business. The parties contracted on Sam's standard terms of business which contained several exclusion clauses and the court therefore held that the UCTA test of reasonableness applied.

Sam had made numerous representations about the software including: a standard money back guarantee (contained within the acceptance testing clause); that the software would assist Hedley by producing reports required by the Regulator; and that they were absolutely confident that there were no technological or functional obstacles to implementing InterSet at Hedley's. Unsurprisingly, after the contract was signed and the software installed problems arose some of which were not resolved and Hedley's then decided to outsource their requirements to a third party services supplier. Sam claimed for the unpaid instalments of the licence fee and Hedley's counterclaimed for damages. The Judge carefully considered all the facts of the case including that the parties were of equal bargaining position and that they were both relatively small companies. Interestingly, Hedley's had a remedy under the contract of being able to reject the software and get their money back if it did not meet the acceptance criteria. Hedley's however did not make use of this remedy despite making numerous complaints to Sam about the software. The Judge found that the exclusion clauses in the contract excluded any sort of damage which was likely to arise as a matter of practice and that Hedley's remedy was therefore to reject the software. This did not however make the exclusion clause unreasonable. Therefore, although judgement was given to Sam the damages which were awarded were very small as the Judge considered that Sam should not be entitled to claim for the cost of repairing the errors in the software.

The Law Commission Report on Unfair Contract Terms

The Law Commission Consultation Paper on Unfair Terms in Contracts has come up with some key recommendations which can be summarised as follows:

• Replacing the Unfair Contract Terms Act (UCTA) 1977 and the Unfair Terms in Consumer Contracts Regulations (UTCCR) 1999 with a single piece of legislation – greater control over business to business contracts;
• Rationalising the controls over non-negotiated terms in business-to-business contracts, so that these apply not only to clauses that exclude or limit liability but also to other unfair terms that have not been negotiated between the parties;
• Re-writing the legislation in a way that is clearer and more accessible;
• Requiring that the terms of a contract should be "transparent"; and
• That the new legislation should apply to terms in cross border-contracts for the supply of goods to consumers.

The Commission will be publishing a Final Report (together with a Bill) in late 2003 or early 2004.

Liquidated Damages

The reason for having liquidated damages as a topic in this update section is because of the recent case of Jeancharm Ltd (t/a as Beaver International) and another –v- Barnet Football Club Ltd. As you will be aware, a liquidated damages clause is a method by which a party can specify the damages that it believes that it will suffer if the other party to the contract fails to perform in the manner required.

As example clause from an IT related agreement is:

If the Supplier fails to provide the Software Ready for Use by [ ], then the Supplier shall pay the Client as and by way of liquidated damages for the loss and damage sustained by the Client resulting from the delay during the period from [ ] until the date on which the Supplier provides the Software the sum of £[ ] for each day of such delay up to a total maximum of £[ ]. The payment of liquidated damages shall not relieve the Supplier from its obligations to provide the Software Ready for Use by [ ] or from any other liability or obligation under the Agreement.

However, English law has also long has the policy that contractual clauses which are put into an agreement to penalise the other party for non-performance would be void as a matter of public policy. The essential principles of this policy are set out in the 1915 House of Lord case of Dunlop Pneumatic Car Co –v- New Garage Motor Co and the court decided in this case that the question of whether a clause was a penalty or not should be assessed at the time the parties were making the contract. Therefore, in order to have an effective liquidated damages clause it is necessary for the clause to be a genuine pre-estimate of the loss likely to be suffered by the party as a result of the other party's non-performance. The case of Jeancharm involved the examination by the courts of the whether the liquidated damages represented a penalty and was therefore not able to be enforced by the party seeking to rely upon it.

The facts of the case were simply that Jeancharm, the claimants entered into a contract for the supply of football kit to Barnet football Club. There was a clause in the agreement that said that if Barnet was late in paying for the kit it would pay interest on the unpaid sums at a rate of 5% per week which equates to an annual amount of interest of 260%. The agreement also specified that Jeancharm should pay 20 pence per garment per day in late delivery. There were various disputes under the agreement and Jeancharm obtained a judgement against the defendants for the failure to pay for the football kit. Jeancharm also tried to apply the interest clause and Barnet Football Club claimed that the clause was unenforceable as a penalty clause. The judge disagreed and stated that the clause applied and this therefore significantly increased the amount of damages that had to be paid by Barnet Football Club. They therefore appealed on the grounds that the interest clause did constitute a penalty clause and was therefore unenforceable.

The court decided that in order to asses whether the clause was a penalty clause it would be necessary to look at the contract as a whole and also to assess the relative bargaining power of the parties although it was acknowledged that this would not be conclusive in determining whether the clause was a penalty. In this case the court decided that the rate of interest of 260% per annum was bound to be penal in nature and had nothing other than a deterrent function and accordingly was unenforceable.

The lesson to take away from this case is that in any liquidated damages provision it is very useful for the party seeking to rely on the case to have written evidence created at the time the contract was being negotiated showing why it decided that it need to have a clause specifying damages to be paid at a certain rate. Simply put, if the claimant can show that it was genuinely reasonable at that time for there to be a payment by the other party of a certain amount in the event of their failure to perform the clause is more likely to be held to be enforceable.

Recent Case on Agency

The law in this area is governed by the Commercial Agents (Council Directive) Regulations 1993. These Regulations, when introduced brought about a substantial change in the law of agency in the UK. Previously in the UK an agent would not have been entitled to any compensation on the termination of his or her agency agreement. However, in some of the other European countries much greater protection had been afforded to commercial agents and in order to harmonise the law across Europe in this area. Although the Regulations specify that a commercial agent should be entitled to some compensation for the loss of his or her or its agency relationship they did no specify the level of that compensation. There has been lost of argument about what the level of compensation should be for the commercial agent in the event that the agency relationship is terminated.

The recent case of Tigana ltd –v- Decoro [2003] EWHC 23 (QB) offers some guidance in the area of the amounts of compensation due to an agent on the termination of the agency contract. The facts of the case are essentially that Tigana entered into an agency agreement on the 1st January 1999 to act as Decoro's agent in distributing furniture products in the UK. The agreement was to last for one year and ended on the 31st December 2000. After the agreement was terminated Decoro a Hong Kong company continued to receive orders for their furniture from the UK and Tigana therefore claimed for commission and compensation due to it under the sales Agreement and by reason of the application of the Commercial Agents Regulations 1993.

Regulation 8(a)

This Regulation essentially states that: a commercial agent shall be entitled to commission on commercial transactions concluded after the agency contract has terminated if the transaction is mainly attributable to his efforts during the period covered by the agency contract and if the transaction was entered into within a reasonable period after that contract terminated.

The Judge in the case was happy to find that even though the agency relationship had been terminated at the beginning of 2000 the sales of furniture products during this year were "mainly attributable to the efforts of the commercial agent" as required under Regulation 8(a). There is however a second test for those transactions which are concluded after the agency agreement has been terminated which is that the sales need to be completed within a reasonable period after the agency agreement has been terminated. The Judge in this instance concluded that a period of 9 months would be a reasonable period even though the agreement only lasted a total of 12 months. It may be possible to argue that this period of 9 months has been arrived at based on the facts of the case and this is certainly the impression given in the judgement. It should also be noted that the Judge appeared to be very impressed with the agent Mr Coleman who was trading out of his Isle of Man company Tigana. The Judge appears to state in the judgement that the commission that should be payable to the agent should be the commission that would have been payable if the agency agreement had continued for this further period of 9 months. The judgement is however a little confusing on this point as it appears that the figures given by the parties in the trial bundles were disputed at a very late stage by Counsel for the agent.

Regulation 17

Regulation 17 entitles a commercial agent to either compensation or an indemnity on the termination of the agency agreement. An indemnity claim was not an issue the court had to consider as Regulation 17 specifically requires that the contract must provide for the payment of an indemnity otherwise compensation will be payable. The agreement between the parties was silent on this point and therefore, the claim by Mr Coleman was under Regulation 17(6) which provides that the commercial agent shall be entitled to compensation for the damage he suffers as a result of the termination of his relations with his principal.

The court was therefore required to consider if the agent should be entitled to compensation under Regulation 17 given that the agreement expired rather than having been terminated. The Regulation draws no distinction between the termination of the agreement by one of the parties and the agreement just expiring in the ordinary way. Counsel for the supplier suggested that this question of whether compensation should be payable under Article 17 if the agreement just expires needed to be referred to the European Court of Justice for clarification. The Judge found that this was not necessary on the natural meaning of what the Regulation was intended to cover especially as Regulations should be reviewed in accordance with the Directive which they are designed to implement. The Judge also considered the law of some other European states, notably France and Germany in helping him to arrive at this decision and interpretation of the Regulation.

The Judge when considering the quantum for the award under Regulation 17 identified the following features of the agency arrangement as being pertinent to how much damages should to be awarded to the agent in these circumstances:

• the period of the agency arrangement as stated in the agreement;
• the period that the agency in fact lasted up until termination;
• the terms and conditions attaching to the agency as provided in the agency agreement;
• the nature and history of the agency and the particular market involved;
• the matters mentioned in Regulation 17(7) (a) and (b) relating to the principle obtaining substantial benefits linked to the agent's activities and that the agent had not sufficient time to amortise the costs and expenses he had incurred;
• the nature of the client base and the kind of contracts anticipated to be placed (for example, "one-off" or repeat);
• whether the agency is an exclusive or non-exclusive agency;
• the extent to which the agent has bound himself during the agency to act exclusively for the principal and the extent to which the agent is free to act for others ( and whether in the same field of goods or services or not);
• the extent to which the principal retains after termination of the agency benefit (for example, by way of enhanced trade connection of goodwill) from the activities of the agent during the agency;
• the extent to which the agent is free, after termination, to have dealings with customers with whom he dealt during the agency (i.e. is there a restraint of trade clause);
• whether there are there any payments under Regulation 8 (or other Regulations) which ought to be taken into account;
• the manner in which the agency agreement is ended;
• the extent to which the agent and the principal have each contributed to the goodwill accruing during the agency agreement; and
• the extent to which there may have been loss caused by any relevant breach of contract or duty.

The Judge reviewed the small amount of UK case law that there is surrounding this subject including the Scottish case of King –v- Tunnock where two years commission payments were awarded for an agency arrangement lasting over 30 years. He did however draw a clear distinction between this case and the present facts and followed the French approach when considering this issue including the course of not having to taking into consideration whether or not the agent mitigated the loss of his or her agency relationship. The Judge expressed great concern about the "two year rule" which has generally been adopted in French case law and according to some commentators should therefore be followed in English decisions. The Judge essentially formulated his own conclusion on how the damages were to be assessed in this case in relation to the net remuneration of Decoro (i.e. less expenses) for the period of the agency agreement and bearing in mind whether the figure that he eventually arrived at was fair and appropriate.

Clearly careful consideration needs to be given to what should occur on the termination of an agency relationship when the agreement is being negotiated. This case demonstrates that the principal may have to make substantial payments to the agent that he has just got rid of.

The Sale and Supply of Goods to Consumers Regulations 2002

These regulations implement EC Directive 1999/44/EC which is also known as the Consumer Guarantees Directive. The regulations are important because they amend the Sale of Goods Act 1979, the Supply of Goods and Services Act 1982, the Supply of Goods (Implied Terms) Act 1973 and the Unfair Contract Terms act 1977. They came into force on the 31 March 2003.

Briefly the main changes to the consumer protection legislation are:

• consumers have the right to have goods that do not conform to the contract of sale at the time of delivery repaired or replaced, unless that would be impossible or disproportionate or to require the seller to reduce the purchase price by an appropriate amount or rescind the contract (new Part 5A to the Sale of Goods Act 1979);
• the burden of proof when reporting non-conforming goods will shift in favour of the consumer for the first six months after delivery of the goods (new Section 48A(3) of Sale of Goods Act 1979);
• guarantees offered by a producer or seller to a consumer will be contractually binding, and must be written in plain intelligible language setting out the particulars necessary for making a claim under the guarantee and are to be made available to the consumer on request (Section 15 of the Regulations);
• the Regulations also state that any public representations made about the goods by the seller will be pertinent in assessing whether the goods are fit for their purpose and that the goods will remain at the seller's risk until they are delivered (amends Section 20 of the Sale of Goods Act 1979).

Contact Point:

Alex Rutter

Solicitor

CMS Cameron McKenna

T: +44 (0) 207 2503

alex.rutter@cms-cmck.com