Major case on liabilities makes it to the Supreme Court: penalty clauses will never be the same again!

Background

There have been quite a few cases recently on the effect of limitations and exclusions of liability, many of which have gone to the Court of Appeal. This is excellent news for lawyers in search of definitive statements of the law – a Court of Appeal judgment is high authority indeed. However, when a case concerning liabilities goes to the Supreme Court, every lawyer’s ears will prick up and they will rush to see what nuggets that case contains: it is of the highest authority in the land. Are the Court of Appeal judgments broadly correct? Or are do they need qualifying? Were they wrong?

Triple Point v PTT [2021] UKSC 29 is just such a case. Having gone through the High Court, on to the Court of Appeal where the result astounded many commentators, the judgment of the Supreme Court can be taken as settling the law in this area for years to come.

Facts

Triple Point contracted to provide a software system to PTT, a commodities trader based in Thailand. The software was to be based on Triple Point’s existing software package, and annexed Triple Point’s standard terms and conditions to a newly agreed contract. However, the main contract was expressed to prevail over Triple Point’s standard terms. The main agreement was complex and provided many of the terms that you would expect to see in such a software implementation contract including

• warranties that the functionality of the software would be as agreed in the contract
• acceptance testing to verify the above
• payments against achievement of defined milestones
• time for completion of milestones

Liabilities were also dealt with in two parts of the agreement. Article 5 provided for payment of liquidated damages against delay (commonly called a “penalty” clause, though this is not the strictly correct legal term to use).

Liabilities were also dealt with later in the agreement and the troubled wording of Article 12.3 was the main provision considered by the Court. To say that it was easy to construe would be an understatement: the relevant parts will be given below.

In fact, the project was subject to considerable delays, and Triple Point sought to claim from PTT various invoices it claimed were unpaid. This was met by a much larger counterclaim by PTT for its losses, including claims for liquidated damages under Article 5 and a claim for general damages for other losses following termination of the contract, including the costs of re-procurement.

The Supreme Court had to consider three issues.

Issue One – are liquidated damages payable where work is never completed?

The liquidated damages (or “penalty”) clause read as follows,

“5 If [Triple Point] fails to deliver work within the time specified and the delay has not been introduced by PTT, [Triple Point] shall be liable to pay the penalty at the rate of 0.1% (zero point one percent) of undelivered work per day of delay from the due date for delivery up to the date PTT accepts such work, provided, however, that if undelivered work has to be used in combination with or as an essential component for the work already accepted by PTT, the penalty shall be calculated in full on the cost of the combination.” [emph. added]

The decision in the Court of Appeal was based on looking at a  number of older cases on liquidated damages and finding that they could be interpreted in three different ways:

1. as a straight point of construction, the liquidated damages clause does not apply on its own wording;
2. liquidated damages are payable only up to the point of termination (which the Court of Appeal regarded as the orthodox analysis); or
3. the liquidated damages clause continues to apply until the replacement contractor has finished the work

The Court of Appeal relied on an old case, British Glanzstoff Manufacturing Co Ltd v General Accident, Fire and Life Assurance Corpn Ltd [1913] AC 143, to find that the first meaning was the one to be applied in this case, but the Supreme Court thought the Court of Appeal had fallen into error on this point.

The upshot of the judgment of the Court of Appeal was that Article 5 should be understood to mean that liquidated damages were only payable if the project was actually completed. It followed that, if the project was never completed, then no liquidated damages would be payable. This flowed, according to the Court of Appeal, from the words used in Article 5, “from the due date for delivery up to the date PTT accepts such work”. In other words, if PTT never accepted the work, then no liquidated damages became payable – this was simply a consequence of the way the clause had been drafted.

This was a result that caused consternation among many commercial lawyers and commentators on commercial law. The advice at that time was that every liquidated damages clause had to deal specifically with termination, and in particular state whether liquidated damages were payable whether the project was completed or not, and whether they were payable up to termination or some other point of time.

This has been considerably clarified by the Supreme Court. While the wording of the particular clause will of course be decisive, the Supreme Court held that there was no “principle” or legal requirement deriving from the British Glanzstoff case or otherwise to the effect that liquidated damages clauses had to be held in abeyance until completion of the project. If the clause said they were payable for delay, then they were payable at the rate and for the period set out in that particular clause. One could not read in a further implied obligation to wait for completion of the project before demanding payment of the liquidated damages. The Supreme Court took the wording of Article 5 (“up to the date PTT accepts such work”) and said that what it meant was, “up to the date (if any) PTT accepts such work”. 

Issue Two – are damages for Triple Point’s negligent breach capped?

This is an important issue deriving from the fourth sentence of Article 12, which read,

“This limitation of liability shall not apply to [Triple Point]’s liability resulting from fraud, negligence, gross negligence or wilful misconduct of [Triple Point] or any of its officers, employees or agents.”

What does “negligence” mean there? The preceding sentences of Article 12.3 had provided for a total aggregate cap on Triple Point’s liability (sentence (2.)) and also a cap per breach (sentence (3.)). Sentence (4.) was a “carve-out” from those caps – it meant that anything falling within the carve-out resulted in unlimited liability for Triple Point. Much therefore turned on the meaning of this little word, “negligence”.

For the judge and the Court of Appeal, “negligence” in this context meant the tort of negligence – the cause of action where someone carelessly burns down someone else’s factory, or accidentally causes death or personal injury to an individual. If the Court of Appeal was right, then this carve-out from the contractual caps only applied where there was some act by Triple Point that came within this narrow meaning of just the tort of negligence. This would mean in turn that Triple Point’s liability was effectively limited as per sentences (2.) and (3.).

On this issue, the Supreme Court was divided. However, the majority thought that the settled legal understanding of “negligence” included not only the tort of negligence but also the failure to take reasonable care when carrying out a contractual obligation. The effect of this understanding is that the carve-out applied to a far wider range of Triple Point’s activities. While there were specific obligations in the contract (such as the obligation to provide functioning software and to meet milestones) there was a whole range of activities that were in the nature of a duty to carry out services with reasonable care and skill. The majority of the Supreme Court thought that these activities too fell within the meaning of “negligence” in sentence (4.), leading to a much higher liability on the part of Triple Point.

Issue Three –  are liquidated damages included within the caps in Article 12.3?

We have looked at the carve-out in sentence (4.) of Article 12.3, but the preceding two sentences dealt with caps on Triple Point’s liability:

(2.) The total liability of [Triple Point] to PTT under the Contract shall be limited to the Contract Price received by [Triple Point] with respect to the services or deliverables involved under this Contract.

(3.) Except for the specific remedies expressly identified as such in this Contract, PTT’s exclusive remedy for any claim arising out of this Contract will be for [Triple Point], upon written notice, to use best endeavor [sic] to cure the breach at its expense, or failing that, to return the fees paid to [Triple Point] for the Services or Deliverables related to the breach.

The Supreme Court saw these sentences as providing two caps:

• sentence (2.) provided for an aggregate cap on liability for Triple Point in respect of all breaches
• sentence (3.) provided for a cap for each individual breach not involving delay (which was dealt with by liquidated damages)

But what about liquidated damages? Did they come within the cap? If so, then they would reduce Triple Point’s liability for other breaches, as a liability for liquidated damages would “eat away” at the cap in sentence (2.).

The Supreme Court simply applied the words on the page: sentence (2.) simply referred to “total liability” and that is what is meant – so it encompassed damages for delay, damages for defects and damages for any other breaches whatsoever. Therefore any payment of liquidated damages would “eat away” at the cap provided for, leaving less liability for other breaches.

Practice points

Perhaps the most important point to make is that the Supreme Court, especially in the judgment of Lords Leggatt and Burrows, gave a stamp of approval to where we had got with construing and applying liability clauses. As we have seen with recent decisions in the High Court and the Court of Appeal, we have moved a considerable distance from strained constructions of caps and exclusions towards a more natural reading of the words and an open acceptance that parties will want to limit their liability. It comes down to applying what the parties have agreed in their agreement.

There is of course the Unfair Contract Terms Act 1977, which applies in some narrow but important cases, notably where one party contracts on the other party’s standard written terms of business. However, the effect of this is to encourage the courts, by and large, to leave the allocation of risk to the parties and not to take a supervisory role in determining the reasonableness or otherwise of the parties ultimate agreement.

In this sense, there is a thumbs up to the recent line of authorities coming from the courts and no major change.

On liquidated damages, the Supreme Court has restored what most people thought was the right position: the decision of the Court of Appeal had not been widely welcomed and was blamed for introducing considerable doubt into the application of liquidated damages clauses. The status quo has been restored.

This leaves the parties as the “masters of their contractual fate”: giving the parties power to agree the allocation of risk is all well and good provided that they draft something sensible and easy to understand and apply. Where the drafting is as it was in this case, there are more problems.

There are probably those who are going to be concerned that “negligence” was construed as it was in this case. The effect was to broaden the effect of the carve-out making Triple Point face unlimited liability for a large range of breaches. I suspect there are many solicitors and clients of solicitors who will be surprised to hear that “negligence” could mean not only the tort of negligence but also the duty to carry out a contractual duty with reasonable care and skill. The minority judgment is worth reading on this point.

However, the practice point to take away is that you cannot take too much care in setting out liabilities provisions as simply and coherently as you can:

• don’t pile up sentences in one clause – it makes it hard to understand, break it down
• breaking it down means that you have to consider how one sub-clause interacts with the others: it does no harm to make judicious use of phrases such as “subject to …” and “without prejudice to …” to make your meaning clear
• when using a word capable of more than one meaning, define your meaning: now we know that negligence can be used in more than one sense, make it clear what meaning you intend

Caveats

As always, this note deals with one particular case dealing with one contract and one set of facts. Always take professional advice.

This note was written on 27 July 2021 and does not take later developments into account.