Liability for software errors

24 February 2005

Jeroen van der Lee, Louwrens Phoelich

Introduction

Who is responsible for defective software? The distributor or the producer? To what extent can the producer of the software hide behind a contractual exclusion of liability? A recent decision of the District Court of Hertogenbosch addressed these questions[1]. In this case, a customer alleged that “Exact” business software was faulty. The case and its practical implications are addressed below.

Discussion of the dispute

Inducom bought an Exact software package for approximately €14,000 from Effi-Center, an Exact distributor. However, Inducom was not satisfied with the functioning of the software and so did not pay a large amount of Effi-Center’s invoice. Effi-Center initiated legal proceedings, claiming payment of the balance of its invoice. Inducom issued a counter-claim for a refund from Effi-Center (of the part of the invoice already paid) and compensation for the loss suffered (including wasted time of employees and costs of an expert who had been engaged earlier). Effi-Center thought that even if the software was defective, Exact was responsible and should bear any costs. Consequently, Effi-Center called Exact as a third-party into the proceedings and claimed compensation from Exact inter alia for the sum which Effi-Center might be liable for to Inducom.

Defective software?

The first issue facing the District Court was whether the software contained errors. The court appointed an expert who found three technical errors, including one serious error that meant that after certain error messages had been displayed it was necessary to switch the computer off and:

  • this was “also the reason for the regular file mutilations, which prompted users to repeatedly shut down the software, until Exact had repaired the mutilations”
  • this way of error handling, proposed by the helpdesk, had not been laid down in the manual
  • “the regular prevention of errors necessitating a restart of the Windows operating system is an indication of disordered programming”, which confirmed his opinion “that the Exact programmers are in insufficient control of the programmed processes and miss an overview of it”
  • that it was possible that the errors found were also caused or worsened by the hardware or system software, compounded by the fact that Windows 95 is certainly not error-free. (Although this was acknowledged by Exact, who stated that the software had been programmed in a manner to minimise consequences of the Windows 95 errors.)

The court accepted the expert’s conclusions and judged that Effi-Center, as the seller of the software, was liable for its defects. Inducom was awarded a refund of the amount paid and compensation for its losses. The court rejected Effi-Center’s defence that, as distributor, it was not responsible for errors in the software. In principle, a seller is responsible to the buyer for damage arising from a defective product, irrespective of whether he could do anything about those defects. According to the court, the fact that Effi-Center had not developed the software package and was, therefore, unaware of the errors was not of any significance.

Liability of the software producer to the distributor

The next issue was whether Effi-Centre could recover from Exact the amount of damages it had been ordered to pay Inducom. The court held that Exact was responsible to Effi-Center as the developer of the software. However, Exact attempted to rely on two clauses in the distributorship agreement:

(a) An exclusion of liability clause

(b) A clause limiting liability to 50 percent of the amount invoiced to Effi-Center pursuant to the distributor agreement

The court rejected (a) the exclusion of liability clause on the grounds that:

  • the clause was unacceptable according to the standards of reasonableness and fairness
  • Exact warranted in another clause of the distributorship agreement that its products meet the specifications in its brochures

The court accepted (b) the limitation of liability clause but this was immaterial because the distributorship agreement had a fifteen year term and the amount invoiced following the agreement far exceeded the damages sought by Effi-Center.

Conclusions for use in practice

Two conclusions can be drawn from this judgment. Firstly, a distributor is primarily responsible to the customer for the software he supplies. Secondly, clauses excluding all liability may not be effective, especially in vertical agreements, i.e. between a producer and distributor.

The distributor’s position

There is a risk on the distributor of ‘getting caught between two fires’. He is responsible to his customer for defective software and then has to attempt to recover damages from the producer. Effi-Center was fortunate that the court did not accept Exact’s (a) exclusion of liability and that (b) the limitation of liability clause was set too high to affect damages in this case. Courts will not usually find terms between businesses unreasonable or unfair. Therefore, on one hand the distributor must strike the right balance between the arrangements with his customer and on the other hand the arrangements with the producer. The arrangements between the respective parties should be ‘back-to-back’, i.e. the same agreements must apply as between the customer and the distributor, and the distributor and the producer. Back-to back arrangements may not always be possible in practice because:

  • the negotiating position of the producer towards the distributor is often stronger than the position of the distributor towards his customer. Market leaders, such as Exact, may not need to negotiate with smaller distributors
  • legislation may protect the customer.

Excluding liability

The court was unwilling to sanction an agreement that with one hand gave something, i.e. a warranty that the software works in conformity with the specifications, whilst with the other, taking it back i.e. by an exclusion of liability.

The implication here, although not expressly referred to in this judgment, is that courts may be more sympathetic towards reasonable limits on liability than full exclusions of liability. Consequently, Effi-Center may not have been able to recover had Exact not attempted to fully exclude liability but rather had, for example, limited its obligations to replacing faulty software or limiting its liability to the invoice value of the defective software package. It should be noted that the same principles may be applicable to the distributor in his agreement with the customer.

Customers’ position

Finally, while it may be reassuring to see courts ruling that customers can recover costs for defective software, it is noteworthy that experts will not always be as clear and univocal and that the distributors may often limit liability in their terms and conditions.

Therefore, customers must not assume, from this judgment, that the courts will always protect them. It will not always be as easy as this to recover damages for defective software from the distributor or producer. Consequently, customers should:

  • ensure that any contract with a distributor protects their position
  • implement adequate testing procedures before accepting the product


[1] Hertogenbosch District Court Judgment, 13 October 2004. Note: this is judgment by a ‘lower’ court rather than appellate court. The judgment may appealed.

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