High Court

Irish Telephone Rentals Limited
										(Plaintiff)

v.

Irish Civil Service Building Society Limited
										(Defendant)

No. 1327 of 1988
[8th of February, 1991]

Status: Reported at [1991] ILRM 880

Costello J. 
The plaintiff’s main business, as its name indicates, is the letting on hire of telephone installations and ancillary equipment. The defendant, as its name proclaims, is a building society. For many years prior to 1982 the plaintiff and the defendant had enjoyed a mutually beneficial ongoing business relationship and when, in that year, a major extension of the defendant’s head office in Molesworth Street was put in train and a new telephone system required, the defendant naturally turned to the plaintiff to supply it. This it did and the parties entered into a principal hiring agreement in April 1982 and, in subsequent years, seven supplementary agreements. The defendant also hired from the plaintiff an internal broadcasting installation to supply an internal paging system. The first broadcasting contract was dated 17 January 1985 and it was followed by a supplementary contract on 3 January 1986.
The defendant terminated all their hiring contracts with the plaintiff in May 1988 claiming that the defects in both systems justified it in doing so. These proceedings resulted. The plaintiff contends that the termination was wrongful and amounted to a repudiation of the defendant’s contractual obligations. Their claim is for £70,898.27 by way of liquidated or agreed damages together with £3,607.33 in respect of arrears of rental. Alternatively they claim damages for breach of contract The facts relating to the two main contracts are different and I will deal firstly with the telephone contract.

Telephone Contract

The development of the defendant’s head office was undertaken in two phases, firstly, the offices on the Westmoreland Street side of the site and then the offices on the D’Olier Street side. Mr. Evans, the defendant’s engineer, showed the plans for the phased development to the plaintiff. From these the plaintiff was able to ascertain the total office space contemplated in the overall development, the probable number of staff when the development was completed, and the position of the floor boxes from which internal telephone connections could be made. No specification was prepared and the choice of an appropriate telephone system was left entirely to the plaintiff. The main telephone contract was dated 30 April 1982. Under it the defendant agreed to hire a ‘Mitel’ SX 200 Switchboard, an operator’s console, 20 exchange lines (that is, internal lines to staff ‘phones), 28 push button instruments, 2 ‘Kirk’ instruments. An annual rent of £1,800 (payable quarterly) was provided for, and provision was made for an annual review of this rent. The hiring was to last for 14 years. Clause 11 contained the clause on which the plaintiff’s claim for liquidated damages is based and I will return to it later in this judgment. Between April 1982 and September 1987 seven supplementary contracts were entered into under which the defendant hired additional extension lines and ‘phones bringing the total number of ‘phones hired to 78. These new contracts involved the payment of extra rentals. At the date of termination the annual rent in respect of the main contract and supplementary contracts was £12,505.16.
At the end of 1985 and on different occasions in 1986 complaints were made by the defendant to the plaintiff about the manner in which this system was working. In March of 1987 the defendant enquired what sum was payable under clause 11 should it wish to terminate the hiring and it was informed that the amount due would be £87,178.03 plus the sum outstanding for current rent of £4,823.14. Later in 1987 the defendant obtained the assistance of a telephone systems consultant who wrote to the plaintiff on 11 February 1988 sending a detailed specification for a new telephone system and requesting a quotation for the new system from the plaintiff. The plaintiff’s quotation (which included a claim for £55,980 ‘by way of premature cancellation of the existing telephone contract’) was not accepted and the defendant purchased another system from a rival firm. By registered letter to the plaintiff’s parent company of the 23 May 1988 the defendant explained why the plaintiff’s quotation was not accepted and terminated all the existing hiring contracts. The plaintiff replied on 17 June 1988 advancing the claims which are now incorporated in the present proceedings.

(a) Were there defects in the system?
The system which the plaintiffs installed worked satisfactorily until about the year 1985. From 1985 however problems in relation to it arose which became progressively worse as the volume of the defendant’s business increased causing greater demands on the telephone system. The complaints which the defendants had with the system were two-fold, but inter-related. Firstly incoming callers began to experience very long delays in having their calls answered. They heard the ringing tone but the telephone operator failed to respond to it. Secondly, calls transferred internally from members of the defendant’s staff were subject to being cut off and reverting to the switch. The delays which outside callers experienced were very extensive. The defendant’s solicitor told me how he was required regularly to ‘phone his clients and how he experienced very excessive delays in attempting to do so. On one occasion he decided to time the delay - it lasted for 22 minutes during which time the ringing tone was heard but was left unanswered. The manager of the defendant’s Dundrum branch described to me how difficult he found it was to get through to head office. He was required to ‘phone on a daily basis and frequently. His estimate was that three out of every ten calls involved a delay of about five minutes before the call was answered. The consultant called in to advise the defendants gave up using the defendant’s listed number because of the delay problem. Many complaints about the delay were made by members of the public to the defendant’s telephone operator and other members of the staff.
The internal problem was related to the ‘cradle-tap’ or ‘cradle-flash’ system for transferring internal calls. Instead of a hold-button on the internal ‘phone when a call had to be transferred (for example, from a secretary to her principal or from one member of the staff to another) the cradle of the telephone had to be tapped. The tap had to be exact. It had to be held for at least a quarter of a second and not more than half a second. If the tap was for less than a quarter of a second nothing would happen. If it was for more than half a second the call would revert to the switch. This produced the phenomenon referred to as ‘backing up’ by which a great number of calls which were cut off by the cradle tapping system would queue at the switch for the operator’s attention. Incoming callers became part of the queue. The evidence satisfies me that a high proportion of attempts to transfer calls resulted in the calls reverting to the switch. Staff found the system frustrating and to avoid it a practice developed by which they requested a colleague to ‘phone the operator to effect the transfer rather than attempt to do so by the cradle-tapping method.
The situation caused by the backing up of calls was aggravated by another feature of the system. There were four hold-buttons on the operator’s console. This number was not sufficient for the volume of calls but in fact only three were operative in 1987 and 1988. This meant that on only three incoming lines could the operator answer the caller and put the caller on hold. Thus the delays suffered by callers were due to a combination of an inadequate number of hold-buttons and the backing up of calls at the switch caused by the cradle-tapping system.
Complaints about the system were made verbally to the plaintiffs by Mr. Nolan the defendant’s general manager. He complained about the system at a meeting in December 1985 and at six meetings in 1986. A letter written in May 1987 requiring information about the amount payable under clause 11 should the defendants terminate the contract was written because of dissatisfaction with the system. This dissatisfaction deepened and towards the end of 1987 an expert consultant was called in to advise the defendants. As a result specifications for a new system were prepared and tenders sought. When the plaintiff’s tender was not accepted the letter of 23 May 1988 was written terminating the contract. I am satisfied that this decision did not result from a desire to avoid contractual obligations which the defendants found to be onerous but because of defects in the system which they found to be insupportable.
In reaching the conclusion that the problems which the defendants encountered were caused by the defects which I have outlined I have not lost sight of other possible causes. I have heard the evidence of the telephone operators who were employed by the defendants at the relevant time. They were both experienced telephonists and the delays were not caused by their inadequacies. There are now two operators and a full-time receptionist employed by the defendant. But this is because of the expansion in the defendant’s business which has occurred since 1988. Prior to and at the time of the termination of the contract the telephonist acted as a receptionist. But there is a record of the level of daily calls received by the defendants at the date of termination and these could have been adequately handled had the system not been defective. The problems the defendants encountered were not the fault of the Telecom Éireann lines or of an inadequate number of lines for incoming calls at that time. I have had evidence that the Mitel System with cradle-tapping internal ‘phones has been installed elsewhere and works well. There are, however, several possible explanations as to why the system worked well elsewhere but not on the defendant’s premises. For example, the calibration on the cradle-tapping system in other premises might have been different or the requirements for transferring internal calls might have been on a lower level, so that the fact of the system working well elsewhere does not vitiate the conclusions which, on the balance of probabilities, I have arrived at on the evidence in this case.
That evidence satisfies me that by 1988 the delays experienced by outside callers were of a serious nature. As a result the installations hired by the defendants did not provide a telephone communications system which would enable persons wishing to communicate by telephone with the defendant to have their calls answered within a time which would be acceptable to a reasonable caller. The system, in my judgment, was by that time not fit for the purpose for which it was being hired.

(b) Did the defects in the system constitute a breach of contract?
Clause 2 of the principal hiring contract (and in the supplementary hiring contracts) provided that the agreed hiring rent was to be paid during the continuance of the contract ‘for the hire of the installation and for maintenance of same in good working order’. The defects which I have outlined seem to me to be a breach of the plaintiff’s obligation under this clause as they failed to provide installations during the continuance of the hiring in good working order. The working order of the system by 1988 could not be described as being ‘good’ and it seems to me that the plaintiffs were in breach of an express term of their contracts.
The defendants were also in breach of a term implied by the Sale of Goods and Supply of Services Act 1980. By virtue of s. 39 of that Act in every contract for ‘the supply of a service’, where the supplier is acting in the course of a business and where goods are supplied under the contract there is a term implied that the goods will be of ‘merchantable quality’. In this case the contract which was entered into between the parties was for the supply of a telecommunications service. The plaintiff entered into the contract in the course of its business as suppliers of such a service. And goods, namely, a switchboard, console and telephone sets, were supplied under it. ‘Merchantable quality’ has the same meaning in s. 39 as it has in s. 14 (3) of the Sale of Goods Act 1893 (inserted by s. 10 of the 1980 Act). Goods are of ‘merchantable quality’ if they are as fit for the purpose for which goods of that kind are commonly bought and as durable as it is reasonable to expect. The durability of the goods is not in question in this case. What the defendants contend, and I think correctly contend, is that the goods which they hired were not fit for the purpose of providing a reasonably efficient telephone system. There was, in my judgment, a breach of the term implied by s. 39 of the 1980 Act.

(c) Did the plaintiffs breach of contract discharge the defendants from further performance of the contract?
The issue which arises now for consideration is one which arises in many cases. It does not follow that because one party is guilty of a breach of contract that the other may treat himself as discharged from obligation further to perform the contract.
There may be many cases in which the court, when presented with a problem of this sort, may be required to consider whether the term which was broken was ‘a condition’ or a ‘warranty’ or, a ‘fundamental term’ of the contract but, as the frequently cited case of Hong Kong Fir Shipping Co. Ltd v Kawasaki Kisen Kaisha Ltd [1962] 1 QB 26 shows, this is by no means a necessary exercise to be undertaken in every case. I think the approach suggested by the judgment of Diplock LJ at pp.65 and 66 of the report is appropriate to this case. In answer to the question ‘In what event will a party be relieved of his undertaking to do that which he has agreed to do but has not yet done?’ he said:-

The contract may itself expressly define some of these events, as in the cancellation clause in a charter party; but, human prescience being limited, it seldom does so exhaustively and often fails to do so at all. In some classes of contracts such as sale of goods, marine insurance, contracts of affreightment, evidenced by bills of lading and those between parties to bills of exchange, parliament has defined by statute some of the events not provided for expressly in individual contracts of that class; but where an event occurs the occurrence of which neither the parties nor parliament have expressly stated will discharge one of the parties from further performance of his undertakings, it is for the court to determine whether the event has this effect or not.

The test whether an event has this effect or not has been stated in a number of metaphors all of which I think amount to the same thing: does the occurrence of the event deprive the party who has further undertakings still to perform of substantially the whole benefit which it was the intention of the parties as expressed in the contract that he should obtain as the consideration for performing those undertakings?

If this question is posed in this case there can be only one answer to it. The ‘event’ which occurred in this case is the development of a situation in which the installation which the defendants had hired significantly failed to fulfil its purpose. This ‘event’ has deprived the defendant of the whole of the benefit which it was intended the defendant would obtain from the hiring agreements. The defendant was therefore, in my opinion, discharged from further performing the hiring agreements and was entitled to treat the contract as being at an end and request the plaintiff to take back their installations. It follows therefore that the plaintiffs are not entitled to rely on clause 11 of the contract and that their claim for damages for breach of the hiring contracts relating to the telephone installations also fails.

The broadcasting contracts

The first of these contracts, designed to provide a paging system in the defendant’s head office premises, was dated 17 January 1985, a supplementary contract being dated 18 January 1989. Under these contracts the plaintiff let on hire to the defendant a 60-watt amplifier, a microphone and a number of loudspeakers for a period of 12 years, the terms of hiring being similar to those in the telephone contracts. There was a rent review clause, by the application of which the annual rent had increased to £1,438.16 when the contracts were terminated. Using the formula contained in clause 11 on agreed liquidated damages in the event of repudiation the plaintiff’s claim the sum of £7,936.27 liquidated damages for the nine years remaining of the hiring contract together with a quarter’s rent claimed to be due for 1988.
The circumstances of this part of the case are entirely separate from those relating to the telephone contract. The complaint here is that the loudspeakers were too loud and that they had no individual volume controls to enable the sound to be reduced as a result of which some had to be disconnected. Three were disconnected on Mr. Kelly’s floor and six others may have been. But the evidence also establishes that this defect could have been easily remedied by what has been referred to as ‘tapping’ the offending loudspeakers. I do not think, therefore, that the defendant has established any breach by the plaintiff of these contracts; it should have given an opportunity to the plaintiff to rectify the complaint. Even if a breach of contract had been established it was not one which would have entitled the plaintiff to terminate the contract on the basis that the breach discharged its obligation to continue the hiring.
What falls therefore now for consideration is whether the plaintiff is entitled to an award under clause 11 or whether this clause, as the defendants contend, is a penalty clause and therefore unenforceable. If it is then I must assess damages according to common law principles.
Clause 11 provides as follows:-

If the subscriber that is, the defendant shall repudiate this contract and the company that is, the plaintiff shall accept such repudiation so as to terminate this contract the company may thereupon remove the installation and the subscriber shall pay to the company all payments then accrued and also a sum equal to the present value on a 5% basis of the remaining rentals that would have been payable under this contract if not so terminated less an allowance of 25% to cover the estimated cost of maintenance and value of recovered material. The said sums shall be payable as liquidated damages it being an agreed estimate of the loss the company would suffer.

I have the following comments to make on this clause.
(1) The estimate of the plaintiff’s loss arising from premature termination is based on the gross rents outstanding for the unexpired term of the contract. However, the clause accepts, and correctly accepts, that the plaintiff is not entitled to the full amount of these rents. It also accepts that whatever may be the figure for the agreed loss which the plaintiff may suffer that figure should be discounted because instead of receiving the balance of the rents in installments over the years an accelerated payment of the rent will be made to the plaintiff. The discount in clause 11 is 5%. Whilst the defendant readily accepts the principle of discounting it is urged that the sum estimated for the plaintiff’s loss should be discounted at a higher rate.
(2) The figure for the gross rent is to be reduced, according to clause 11, by a further 25% of the discounted rent because (a) the plaintiff will have been saved maintenance costs during the unexpired term and (b) an allowance should be given for the value of the installations recovered. The plaintiff’s evidence is that the 25% deduction was calculated by allowing a figure of 5% of the discounted gross rent as the percentage attributable to maintenance charges and 20% of the discounted gross rent as the percentage attributable to the value of the returned installations.
(3) It will be observed that the formula is based on a deduction from the gross amount of the outstanding rent of a sum equivalent to 28.75% of the gross rent (25% of 5% of the gross rents) in respect of the estimated cost of maintenance and the estimated value of the recovered installations. The clause was attempting to make an estimate of what the plaintiff would lose by the contract’s premature termination. As the correct measure of the plaintiff’s loss on premature termination at any point of time during the life of the contract is the profit it would have earned in the outstanding period of the contract’s life the formula in clause 11 can only be correct if it produces a figure which approximates to that profit. It follows, therefore that this clause can be shown to be a correct estimate of the plaintiff’s loss if in every case of premature termination the profit thereby lost is 71.25% of the gross rental then outstanding.
(4) Clause 11 is a standard clause. All the plaintiff’s hiring contracts contain this estimate of the loss suffered on each of the plaintiff’s contracts should they be prematurely terminated. The defendant has submitted that the sum calculated in accordance with the condition does not represent a genuine pre-estimate of the actual loss which the plaintiff sustained as a result of the wrongful repudiation of the hiring agreement but is a penalty clause which the court should not enforce. The courts have evolved various rules for considering whether a stipulated sum is a penalty or a genuine pre-estimate. That which is relevant to present case is that stated by Lord Dunedin in Dunlop Pneumatic Tyre Co. Ltd v New Garage and Motor Co. Ltd [1915] AC 79 at 87:-

It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.

The application of this principle is to be seen in the majority decision of the Court of Appeal in England in Robophone Facilities Ltd v Blank [1966] 1 WLR 1428 in which the court considered a contract for the hiring of a telephone-answering machine for a seven year period which was repudiated before the hiring began. The hiring agreement contained a clause which made provision in the event of premature termination for the payment of agreed liquidated damages equal to 50% of the total of the rentals due. In deciding that the sum of 50% was a genuine pre-estimate of loss and not a penalty Lord Diplock examined what would be recoverable by way of damages assessed on common law principles and concluded that because 50% of the gross rent would not produce a figure which was ‘extravagantly greater’ than those damages the clause was enforceable.
Before considering in greater detail the operation in this case of clause 11, I should give some more detail of how the plaintiff’s claim is made up.
The plaintiff has calculated that there were nine full years of the agreement to run from the date of termination. The annual rent at that time (which had been increased over the years pursuant to the rent revision clause) was then £1,438.16. This annual rent was discounted over a nine year period by 5% giving a discounted figure of £10,222.15. There was added to this one quarter’s rent unpaid in 1988 (that is, £359.51) giving a total of £10,581.66. A figure of 25% of this sum was then calculated, that is a sum of £2,645.42. This was deducted from the sum of £10,581.69 giving a figure of £7,936.27. It is to be noted that the gross rent for the unexpired nine year period of the hiring was £13,043.62 according to these calculations.
I have come to the conclusion that the formula contained in clause 11 does not produce a liquidated sum that can properly be regarded as a genuine pre-estimate made at the date of the contract of the loss which the plaintiff would suffer should the contract be prematurely determined and that it is in reality a penalty and therefore unenforceable. My reasons are as follows:-
(a) In estimating the plaintiff’s loss clause 11 correctly allows a deduction from the gross rents of the sums saved in maintenance charges. But the evidence establishes that the 5% figure is an estimate not of all the maintenance charges which would have been incurred had the contract run its course but only an estimate of the cost of materials used in maintenance and expenses such as daily allowance, petrol and the travelling expenses of maintenance staff. The wages of the maintenance staff are excluded. Support for this approach is claimed by the plaintiff from an unreported judgment of the High Court in England (the transcript of which was made available) in the case of Telephone Rentals Ltd (the plaintiff’s English parent company) v Photophone Ltd, delivered 8 February 1957. I do not think that this approach is correct and, with respect, I cannot follow that judgment to which I was referred. In estimating the loss which the plaintiff would suffer the draftsman of clause 11 should have attempted to estimate the net profit which the plaintiff would have earned had the contract been performed. This net profit should have been calculated by deducting the actual total costs of maintenance and not only a proportion of those costs. It seems to me that this error produces an estimate very much in excess of the plaintiff’s actual loss and cannot be regarded as a genuine pre-estimate of that loss.
(b) The clause makes no allowance for other deductions which in my judgment should have been made from the gross rent figure. The evidence establishes that when originally fixing the rent under the contract the plaintiff took into account not only the likely maintenance charges but also finance charges, administrative costs and engineering costs. Any genuine calculation of the actual loss likely to be suffered from premature termination should make an allowance for these charges as otherwise the plaintiff would receive more than the profit it would have made had the contract run its course. As I will show later it would have been a simple enough matter to estimate what that profit would have been. But by only deducting maintenance charges (and only a portion of such charges at that) the clause seriously overestimates the profit which the plaintiff would have made on the hiring.
(c) Part of the 25% deduction is based on an estimate of the value of the materials obtained at the date of premature termination. The evidence established that the clause was based on the assumption that this value would be 20% of the discounted gross rents. This, in my view, is an entirely arbitrary figure and cannot be regarded as a genuine pre-estimate of the value of the recovered installations. It is to be borne in mind that the hiring was to last for twelve years and that there was a rent variation clause. Perhaps by a coincidence 20% of the discounted rent might at some point during that period approximate to the depreciated value of the installations. But this would be mere coincidence; there is no real connection between the figures produced by these calculations. The facts of this case illustrate the point. 20% of the discounted rent at the date of termination of the broadcasting contracts was £2,116. But in fact the installations when returned were valueless. 20% of the discounted value of the outstanding rents under the telephone contracts was £16,789. In fact their value was only £7,500 (only the switchboard being marketable). It seems to me that the relationship between discounted value of outstanding rents due at any point of time during the contract and the then value of the installations at that point of time is so tenuous that an estimate of the plaintiff’s loss based on this connection cannot be a genuine one.
(d) The result of the operation of the formula is to award a liquidated sum equal to 71.25% of the gross rent, less 5% for accelerated payment. This predicates a net profit of 71.25% had the contract not been terminated. This is quite an enormous net profit. Whilst the onus is on the party who alleges that a clause in a contract is a penalty and not a genuine pre-estimate of the loss which would be suffered by premature termination I think the onus is discharged once the clause in question is based on the assumption that this is an estimate of the profit the plaintiff lost. The plaintiff is engaged in the business of letting goods on hire. Its turnover in its profit and loss account would therefore (apart from an occasional and small sum received for goods recovered prematurely and sold) represent its annual rents received under all its contracts. Its profit and loss account would show the net profit (after deducting all maintenance charges administrative and financial charges and depreciation). This would indicate the average net profit on each of its hiring contracts. If clause 11 (which is a standard clause in all its contracts) is a correct estimate of the net profit made on each of its hiring contracts this would mean that the net profit figure in its profit and loss account would be about 71.25% of its turnover.
The plaintiff has not produced its profit and loss account and so l do not know what it shows. But I am entitled to apply the knowledge of financial affairs which is available to every reader of the daily press from which companies’ net profits as a percentage of their turnover is shown for an extensive range of different classes of businesses. These, of course, vary widely. In the retail trade a net profit of 10% of turnover is an average figure. In some manufacturing companies it may be considerably less or considerably more. A net profit of 71% of turnover would be a staggeringly large one in any business and in the absence of proof that this is what the plaintiff earned I am driven to the conclusion that the estimate of loss contained in clause 11 is not a genuine pre-estimate but is a penalty.
I cannot therefore allow the plaintiff’s claim based on clause 11 and must assess damages based on the actual loss I think the plaintiff suffered.
The plaintiff recovered back the equipment let under the contracts but was unable to re-let or sell them. The plaintiff’s damages will therefore be an estimate of the profit lost on the transaction, appropriately discounted for accelerated payment. The gross rent which would have been received for the nine year balance of the contract was £13,043.62 (assuming no increase, in the rent, an assumption the plaintiff has made in its calculations). I have been given no information as to what the plaintiff’s average net profit is, but bearing in mind that the evidence establishes that the plaintiff’s business is a competitive one (which would oblige them to keep their hiring charges at a reasonable competitive level) and that the plaintiff is a long established firm (which would give it the benefit of a considerable good-will) I would consider it probable that a net profit of 20% of gross rents is what the plaintiff would have earned on average. There is nothing to suggest that there are any special circumstances which would justify an award for breach of this particular contract on a basis higher than average net profit and so the plaintiff’s loss of profit for the last nine years of this transaction is £2,608.72 (20% of £13,043.62). I have very little evidence to help me on how this sum should be discounted and I will, in the absence of evidence, accept the 5% figure contained in clause 11. This means that there should be a deduction of £130.47, giving an award for the loss the plaintiff has suffered for this period of £2,478.29. To this to be added the loss in relation to one quarter of the 1988 rent, namely, £359.51. 20% of this sum, discounted by 5% is £68.04. This gives a total figure for damages of £2,546.69. The plaintiff is entitled to an award of this sum.
I have assessed damages in the light of the facts established in this case. I do not think I am required to assess them on the different basis which the facts established in In the matter of Rank (Ireland) Ltd  [1988] ILRM 751 required.