May 2008

01 May 2008

Never Interrupt Your Enemy When He Is Making A Mistake

"Never interrupt your enemy when he is making a mistake." This famous quote from Napoleon Bonaparte certainly sounds like good advice, but this article considers one situation in which your lawyer will often advise the opposite.

It happens all too often. A software vendor develops software for their customer. The software does not work as anticipated, causing significant loss to the customer. The customer demands that the software vendor come back and fix the software. The vendor does so, but makes it clear that it understands that it is doing so as a complete remedy for the original problems, and that, once the software is working well, no further action will be taken by the customer.

For customers in this situation, Napoleon's advice is often very tempting. If they simply say nothing, the vendor will get on with fixing the software. Then, when the fix is complete, the customer can reveal that in fact it does not view this as a complete remedy and still has every intention of bringing an action to recover its losses. In contrast, if the vendor is interrupted by the premature revelation that its assumption (that the fix will be a sufficient remedy) is incorrect, the vendor may stop work until the dispute is resolved. For this reason, saying nothing can be particularly tempting in cases in which the overwhelming priority is to have the fix completed as soon as possible.

Contractual Position

From a contract law perspective, Napoleon's advice is probably sound. Assuming a reasonably standard contract, the fix by the vendor will be no more than the completion of performance of the original contract. Consequently, it shouldn't give rise to any loss of rights or additional obligations for the customer. In particular, it shouldn't stop the customer from bringing an action in respect of previous breaches.

Therefore, whatever the understanding of the vendor, once the fix is completed, the customer should be able to point to the breaches which led to its loss, and sue for breach of contract to recover its loss. Of course, it will be necessary to show that such breaches exist once performance has been completed but, in a standard contract, there are likely to be obligations which have been breached in this situation, despite the eventual completion. For example, obligations around the timing of completion may have been breached, warranties about the quality of the product at the time of delivery may have been breached, and so on.

Estoppel

Unfortunately, despite the strict contractual position, caution about this approach is not unjustified. This is because of a legal rule often referred to as "promissory estoppel”. This is a rule which has been developed by the courts because of a perception that if one party encourages the other party to behave in a particular way in the belief that the first party will not enforce certain rights, it is not then fair for the first party to exercise those rights. When promissory estoppel is applied, the first party will find itself prevented ("estopped") from exercising the relevant rights, at least in the short term.

In our example above, if an estoppel is found to have been created, the customer may find itself prevented from bringing an action on the basis that it was entitled to have a satisfactory product by the originally contracted time or that it was entitled to receive a product in good working order on the original delivery date.

When Will An Estoppel Arise?

Despite the spasms of fear this rule creates in lawyers, the requirements which must be satisfied by a party claiming it are actually quite tough. In the example situation, the vendor would need to show that the customer has made a promise or representation that it will not enforce its strict legal rights; that the customer intends the vendor to rely on this promise or representation; that the vendor did rely on this promise or representation; and that it would be inequitable for the customer to be able to enforce its strict legal rights.

The first of these is probably the most difficult to satisfy. The promise or representation must be clear or unequivocal, and, in this example, all that the customer has done is remain silent. However, the courts have found not only that a representation need not be express, but that it can be made simply by the conduct of a party, including silence.

The courts have found that mere inactivity cannot be a representation, except in the most extreme circumstances. This is on the basis that it is hard to read anything unequivocal into inaction. However, it appears that the circumstances can be such that staying silent can no longer be classed as inaction. For example, there have been cases in which a failure to object to a known defect or deficiency in performance within a reasonable time has been held to be a representation that the defect or deficiency has been accepted.

In a situation in which there is an ongoing relationship between a vendor and customer, involving conferring about the organisation of the fix, exchanging correspondence and so on, the silence of the customer on one point in the correspondence, namely the assertion that the fix is a complete remedy, may well be seen as something more than inaction. Further, the more expressly and frequently the point is made in the correspondence, the greater the risk that a failure to set the vendor right could be seen as an unequivocal representation that the customer agrees.

The second requirement, that the customer intended the vendor to rely on the representation or promise, will often be reasonably easy to infer from the circumstances of the customer's silence. If the customer actively encourages the vendor to continue with the fix, while ignoring the vendor's assertions about complete remedy, it could easily be inferred that the customer intended the vendor to continue to believe that its assertions were agreed.

Similarly, the third requirement, that there be actual reliance by the vendor on the customer's representation, will often be easy to establish if the correspondence is sufficiently clear in assuming that the customer agrees.

The last requirement is the most troublesome of the four. This is because it is far from clear what is meant by "inequitable". The uncertainty around this point makes the outcome of many cases difficult to predict.

One factor which is important is the ease with which a party can be restored to the position it would have been in if it had not relied on the representation or promise. If it has altered its position to its detriment, it is more likely to be found that it is inequitable for the other party to exercise its strict legal rights. For example, if the vendor has prioritised fixing the problems with a customer's software at the expense of other parts of its business when it would not have done so knowing that it would be sued anyway, this may force the conclusion that exercise of the strict legal rights is inequitable.

Is There Really Much Cause For Concern?

Although the requirements for an estoppel to arise are not all that easily satisfied, it is certainly possible that they could be satisfied, even when a party has merely remained silent. Furthermore, not every case is decided in the Supreme Court, and an argument based on estoppel may well gain some traction in a lower court, even where the requirements are not strictly satisfied.

Should You Always Set The Other Party Straight?

Because the focus of an estoppel argument is so clearly on what is fair, it is helpful to have adopted a straight forward approach. The appearance of having deliberately misled somebody is likely to predispose a court to find against you in an estoppel case. In fact, avoiding the appearance of being deceitful is perhaps as important as navigating around the full set of requirements set out above.

However, there are certainly degrees of risk that an estoppel will arise, and there are commercial considerations which may indicate that such risk should be taken. For example, if having the software fixed is the first priority, and recovering losses is a distant second priority, a decision may sensibly made to risk having an estoppel arise rather than potentially derailing the work.

Consequently, if there is no particular downside to being straight up with a vendor, or if preserving the right to sue for damages is critical, then it is best to be straight up, but there are certainly some situations in which a less cautious approach is justified.

Authors

Earl Gray

Partner - Intellectual Property

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Don Holborow

Partner - Corporate & Commercial

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Karen Ngan

Partner - Corporate & Commercial

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Richard Watts

Partner - Intellectual Property

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Sonya Hill

Senior Associate - Corporate & Commercial

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Mobile: +64 21 403 596

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