Negotiating liability issues in software development agreements

Publications >Negotiating liability issues in software development agreements

 

For Software Development Agreements (Agreements) that involve mission critical systems or high volume transaction websites the software owner or user (Client) may face significant losses in the event of interruption or catastrophic failure of the system.

 

 These losses may be disproportionately high when contrasted to the fees that the Software Developer (Developer) may earn from doing the work.  For this reason Developers should try to limit or exclude liability for various sorts of losses that the Client could suffer.

 

There is of course two opposing views:

	The Developer who wants to limit or remove liability for all types of losses (particularly consequential losses) and make sure that the Client uses it software according to its design; and
	The Client who wants to make sure that they are covered against all losses, and may be reluctant to enter into the Agreement unless they are covered.

 

The negotiating positions of the parties

 

The Client will probably want the Developer to take on greater liability for any damage caused by its software.  Elements that could be used to mitigate the Client’s loss and form the basis of negotiation include:

 

- Extent of liability
Limiting the terms of the Agreement and documenting the extent to which actions survive termination of the Agreement (in other words limiting the period of exposure to risk).

 

- Capping financial losses
Limiting the quantum available and also documenting the exclusions from the cap.

 

- Limiting the scope of liability for loss
for example (consequential loss, negligence, wilful conduct, fraud, third party reliance, indirect losses, property damage (note that the scope of liability will, to a large extent depend on the sort of system that is developed) and may to a certain extent be controlled by the Developer.

 

- Time limits
It may be prudent for both parties to consider limiting the time limit that actions can be brought under the Agreement.

 

Extent of liability

Each party will not want to be accountable for the actions of the other.  Therefore it is important that teh consequences of each party’s actions are documented to ensure that those actions are a factor that affects the quantum of liability. In negotiating this point, both parties need to consider:

 

	Which risks fall within the control of the Client? (For example the Developer may be confident that it can adequately manage the risk of its fraud or negligence, but not damage to the Client's systems due to upgrading of the operating system, or from malicious third party attacks).
	What risks fall within the control of the Supplier, and which risks are shared by both parties?

 

The parties may wish to consider what tradeoffs can be made. For example:

	Mutual damage caps - this can be claimed on the basis that certain risks are within the other party's area of control, or that the value of the contract is not worth the risk involved;
	Levels of seriousness of breach and methods for remedying the breach (for example material v nonmaterial breaches, liabilities attracting liquidated damages);
	Proof of breach (for example strict liability versus causing the breach);
	Changes to indemnity provisions; and
	Changes to price or performance - argued on the basis that the level of risk must be factored into the product.

 

What other means can be used to manage these risks? For example:

	UAT – may provide for risk to shift to the Client after the software has been tested by the Client;
	Client involvement in the Software Development process may assist to manage expectations and satisfy the Client that it is in control;
	Professional Indemnity Insurance - is it available? If so how much is it for? Can it be increased and who pays for it?
	Warranties may be given and matched by an appropriate indemnity for breach.

 

Capping financial losses

The Developer may want to cap the potential losses because:

	it is not prepared to be exposed to the extent of the potential loss in the event of catastrophic failure;
	depending on the Developer’s structure, it’s Directors may not be prepared to accept unlimited liability;
	its professional indemnity insurance has a set maximum payout amount; and
	the margin in the deal will limit the amount of risk that it can assume.

 

The Client's arguments may include:

	it is not prepared to accept liability for losses caused by the Developer; and
	the Developer may wish to increase its price and include unlimited liability.

 

Client's position
Obviously it is in the interests of the Client for the cap on damages to be as high as possible.  Clients will want to ensure their Directors that they are covered in the event of catastrophic failure.

 

Developer's position
It is important for the cap on damages that is ‘in aggregate’ covers all claims not just a per breach, or event basis.  This is because there may be multiple events and resultant claims which could create a multiplying effect on the quantum of damages.

Developers should also be mindful of including a clause that also caps liability for negligence and claims in tort for similar reasons as outlined above.

 

Limiting the scope of liability for loss

It is usual practice to exclude certain events from the liability cap.  The usual exclusions include:

	property loss or damage;
	personal injury (of any type) or death;
	fraud;
	intellectual property breaches;
	wilful misconduct; and
	third party claims.

 

Attention needs to be paid to what matters are to be taken outside the liability cap and how the clauses are worded.  If either party is prepared to accept unlimited liability in relation to these issues, then the partties need to consider in what other ways they will manage these risks, such as appropriate insurance cover and an accepted and regimented development methodology.

 

Client caps
As the liability to pay the Developer is technically a liability under the Agreement, Developers need to take care that this liability is not included in any cap that is agreed to by the Client.

 

Time limits

Limiting the period on which the Client can sue the Developer for damages may appease the Developer but may not be appropriate for the Client. The danger for the Client is that the defect will not be readily apparent or will only occur in certain situations.  Effectively negotiations over this point can be a give and take situation, however some of the mitigating factors outlined above can be used by either party to strengthen their position.

 

Malcolm Burrows

Associate

 

 

"The information contained in this article is general in nature and cannot be regarded as anything more than general comment. Readers of this article should not act on the basis of this comment without consulting one of Rostron Carlyle's legal practitioners who will consider their particular circumstances".

 

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