Update required - Damages for software contract breach to be assessed at date of hearing

What you need to know

• Where a breach of contract occurs in the supply and installation of a software system, damages may be assessed as at the date of the hearing (rather than the date of the breach).  Those damages may be the reasonable costs of rectification.
• Where it would be more efficient and cost-effective to replace the defective system with a newer, upgraded system than to try and rectify the defective system, damages may be awarded for the costs of that upgraded system (particularly when there is a support agreement in place that allows for upgrades).
• To be entitled to a discount for betterment, the defendant bears the onus of proving what, if any, saving was involved.
• A plaintiff may be entitled to recover the remuneration for a casual employee who works solely on responding to issues caused by the breach of contract, but remuneration for other employees' whose time is diverted may not be recoverable.

Background

SEMF contracted Renown to supply and install a software package. When installed in 2013, the system was defective and did not provide the functionally promised. SEMF sued Renown for damages and claimed the costs of replacing the system in 2021 and the costs incurred in endeavouring to remediate the defects (including the time spent by employees).

At first instance (SEMF Pty Ltd v Renown Corporation Pty Ltd [2021] NSWSC 1547), SEMF was awarded damages of $662,344, which included the costs of installing the new system and an amount paid by SEMF as remuneration to one employee who was found to have been engaged specifically to work on solutions to the problems with the system. Renown appealed the award of damages.

Date of Assessment of Damages

Renown argued that the primary judge erred in assessing damages at the date of the trial, rather than at the date of the breach: i.e. whether the damages awarded should be the cost of replacing the software at the date of delivery (when the contract was breached), or at the date of the hearing.

In reaching its conclusions, the Court of Appeal relied on a number of construction contract cases, noting that they are closely analogous to contracts for the supply and installation of computer systems.

From these cases, the Court of Appeal identified that the appliable rule is that the date of assessment of damages is to be determined by considering all the facts of the case, including the conduct of the respondents. In cases like the present one, the principle was that "the proper measure of damages is the reasonable costs of rectification, which will be the costs when they were actually incurred (if they have been incurred by the date of trial), so long as they are not unreasonable; or (if they have not been incurred already), the reasonable costs as proved as at the trial, unless it is established that by not conducting rectification works earlier the plaintiff has unreasonably failed to mitigate its loss." (at [20], emphasis added).

In this case, there was no unreasonable failure on the part of SEMF: SEMF had given Renown an extended period of time to fix the issue, and it was Renown who ultimately concluded it could not do so. SEMF had also taken other steps to try and fix the issue itself.

In the circumstances, the only practical solution was for SEMF to replace the Renown system with the new, updated 2018 system. Renown had not put on any evidence that it would have been a more economical option to try and fix the errors in the Renown system, and the experts agreed installing the 2018 system was the appropriate solution.

Betterment

A further ground of appeal raised by Renown was that there should have been a substantial discount to the damages awarded to take into account betterment.

In obtaining the newer, 2018 system, SEMF was gaining enhancements and improvements to its user experience and interface, and Renown argued this betterment should have been accounted for in the award of damages.

The primary judge correctly identified that there are two circumstances in which an allowance for betterment should be made:

1. When a plaintiff chooses to acquire a more valuable asset than the one being replaced; or
2. Where there is no choice for the plaintiff but to acquire a more valuable asset, when there is a benefit to the plaintiff which is not remote in time or speculative, and which can be quantified.

The Court of Appeal agreed with the primary judge that this case did not fall within either category.

Firstly, SEMF had not chosen to acquire a more valuable asset.

Second, subject to the payment of maintenance fees, under the contract in question SEMF actually would have been entitled to an upgrade to the 2018 system in any event. It would therefore have been entitled to the enhancements and improvements in question.

Renown failed to put on any evidence to show that such an upgrade would not have eventually happened if the Renown system had worked as promised, or that there would have been any additional costs to SEMF involved in the upgrade process. On that basis, Renown failed to prove that SEMF actually made any saving as a result of the award of damages.

Remuneration for Employees

Finally, Renown argued that SEMF should not have been entitled to recover remuneration paid to an employee engaged to respond to the issues with the Renown system.

While the relevant employee had initially been employed to respond to a separate issue, SEMF provided evidence that from October 2015 onwards, the employee was engaged on a casual basis specifically to deal with the Renown software issues, and worked solely on this project.

Because this employee was a casual employee devoted solely to working on issues arising from the breach of contract, he was in a different category to other employees who had had some of their time diverted to work on the same issues.

So what does this mean?

This decision provides greater certainty to plaintiffs in software disputes: provided that it was not unreasonable to wait to take the relevant steps for rectification, a plaintiff may be entitled to an assessment of damages as at the date of the trial, rather than the date of the breach itself, even if waiting also results in improvements to the technology. Given the ever rising costs of software, this will provide comfort to plaintiffs that they will not be left short in having to replace faulty software if they choose to wait and give their supplier a chance to try and rectify.

An interesting question arises as to how this decision would have been made if there had not merely been an upgrade to the relevant software in the intervening period, but an actual change to the technology involved: would SEMF have been entitled to the costs of the new technology without any discount for betterment? This would likely depend on the terms of the contract and whether Renown would have been required to help SEMF transition into any new, better technology that emerged.

There is also useful practical guidance to be found in this decision: if you are dealing with issues arising out of a breach of a software contract, employees should be engaged or reassigned specifically for the purposes of responding to the breach, rather than merely diverting a portion of their time. This should include written terms of engagement specifying the purpose for which the employee has been retained, and time sheets demonstrating the time that the employee has devoted to the issues. This will improve the probability of being able to recover the relevant costs.

If you are a potential defendant, it is worth taking the time to try and quantify any potential improvements the plaintiff is receiving as a result of replacing the software: this could represent a significant saving in damages.

Given the liability position will be fact dependent, both suppliers and purchasers should consider clarifying the risk positions in their contracts for greater certainty.

Authors: Robert Todd, Partner; Imogen Loxton, Senior Associate; and Alex White, Paralegal.