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Fieldfisher Alerter, April 2011
The Technology & Construction Court judgment in De Beers v Atos Origin is rich both in its narrative of a failing technology project and its discussion of a diverse range of legal principles and contract drafting issues. Issues addressed in the judgment include, change control mechanisms; the difference between "wilful misconduct" and "deliberate default"; anticipatory repudiatory breach and whether a claimant is entitled to recover the cost of replacement services even where he has no intention of commissioning such services.
The facts
De Beers engaged Atos to design, develop and deliver a system to manage its diamond supply chain. De Beers’ business was unusually complex and so Atos was given a six week pre-contract period (the "Initiation and Analysis Phase" or "IAP") for requirements gathering and to allow it to assess the project before committing to a fixed price. The output of the IAP was to be a detailed requirements definition and a high level design, leaving the detailed design to be fleshed-out under the main contract. The system was to be developed on an iterative basis through an ongoing cycle of delivery, customer feedback and improvement.
The IAP was not a success. Atos did not allocate sufficient time or resources for this phase; De Beers’ users came to workshops without having agreed their requirements amongst themselves; and at the end of the IAP, De Beers was concerned that Atos had only a limited understanding of its requirements.
Once the main contract was underway, Atos realised that it would have to deliver a much more complex solution than it had originally envisaged, and at a considerably higher cost. To make matters worse, Atos had not allowed sufficient contingency in the fixed price to allow for this risk. De Beers withheld payment against a key milestone. Atos in turn threatened to "suspend" performance (it argued, pursuant to an express contractual right) unless De Beers:
- Waived all claims against Atos to date
- Agreed that Atos would complete the project on a time and materials basis and
- Paid the outstanding invoice.
De Beers refused and Atos "suspended" performance.
The claims and counter-claims
Each party claimed that the other was in repudiatory breach - a breach that goes to the root of the contract and, at common law, allows the other party to choose to treat the contract as at an end. In addition, Atos made a number of claims against De Beers, including for payment for services that Atos argued were outside the agreed contract scope.
The judgment
What evidence could the court take into account, aside from the written main contract?
The first step was for the court to decide what evidence outside the written contract it could take into account in construing the contract. The judge referred to case law in this area that “it is well established that a commercial contract must be read as a whole and in the context of the events that gave rise to it”. The outcome of the IAP and the judge’s conclusions about what Atos knew (or should have known) at the end of the IAP were important factors in the judge’s interpretation of the scope of the contract. The judge stated:
“In my judgment, Atos went into this contract with its eyes at least half open, in the sense that it knew or should have known that it had not acquired a good grasp of the detail of DB’s ... processes and that consequently a great deal of work remained to be done in the way of gathering the detailed requirements, with consequent implications for the development of the design - both in terms of time and resources….. I consider that a reasonable business organisation in the position of DB, having indicated some of its concerns about Atos’s performance during the IAP, was entitled to leave Atos to assess the risk for itself, to put forward a price that included a realistic contingency in case the project should prove much more complex than was apparent from the investigations to date and, if it could do so, to negotiate any variation of the proposed contract in order to reduce its exposure.”
Contract changes and scope
In this case, the complexity of the solution required to meet De Beers’ high level requirements only became clear to Atos once the project was well under-way and after the fixed price had been agreed. Atos argued that, in certain specific instances, where a more complex solution was required than originally envisaged, this should be treated as a contract “Change”, entitling it to additional payment.
The Court had to first determine the baseline against which “changes” should be measured. The relevant parts of the contract stated:
“The Supplier shall work closely with the Customer’s business user representatives to refine and further detail the requirements set out in the Specifications (Schedule 2) during the Detailed Analysis phase” and
“The System will be delivered in accordance with the Specifications [set out in named documents] as the same may be enhanced or clarified by the Detailed Design.”
De Beers argued that the specifications were "living" documents and that Atos was under an obligation to deliver a system to support the requirements set out in the final version of the specifications. The versions that existed at the date of the contract were irrelevant. Atos argued that the scope of the project was defined in the specifications in their form at the contract date. The words “as the same may be enhanced” simply showed that the specifications were not frozen in time. The Court agreed with Atos and took as the baseline the specifications in their form at the contract date.
The court then had to consider whether each item of “additional” work claimed by Atos was a contract “Change”. Referring to agreed expert evidence, the court drew a distinction between changes in “breadth" - defined by the expert as “changes that introduce functionality that was clearly outside the scope of the project when it was planned and which may even have been explicitly stated to be out of scope”; and changes in “depth” - “changes that add scale or complexity to the work that was legitimately envisaged on the basis of the stated requirement, but that do not extend the functionality into wholly new areas”. Changes in breadth would entitle Atos to additional payment; changes in depth would not. In this case, the court ruled that most of the changes claimed by Atos were changes in depth.
Comment: Drafting an iterative development contract, particularly on a fixed price basis, presents challenges, especially when it comes to defining the scope of the project. Suppliers will want to ensure that they are suitably protected against any nasty surprises, and whilst change control procedures work well where the functional and technical specifications for the solution are agreed up-front in considerable detail, they are much harder to apply against a high level set of business requirements that the parties intend will evolve during performance of the contract. A customer may prefer the certainty of a fixed price arrangement, but that comes at a price as suppliers are likely to build-in a high risk premium. Contract mechanisms such as baseline assumptions and dependences can help to mitigate, but cannot eliminate, the risk of scope creep.
The difference between “deliberate default” and “wilful misconduct”
It is common for liability for “wilful misconduct” or “deliberate default” to be carved out from the liability caps in a contract so that the parties have unlimited liability for resulting losses. Although there are a number of cases on the meaning of “wilful misconduct”, before De Beers there was little judicial guidance on the meaning of “deliberate default”. In this case, the judge said:
- Wilful misconduct is wider than deliberate default; and encompasses deliberate default.
- Wilful misconduct refers to conduct by a person who knows that he is committing and intends to commit a breach, or is reckless whether or not he does so.
- There will be a deliberate default if the relevant person knows that their act is a default. If the person is merely reckless, the default will not be “deliberate”. De Beers had tried to argue that deliberate default includes any deliberate conduct (as opposed to something done accidentally or inadvertently) that happens to result in a default, whether or not that was intended. The judge said that he did not have an issue with De Beers’ argument as a concept. However, he rejected De Beers’ argument because, in the context of this particular contract, he found it hard to envisage any sort of conduct which would fall within this interpretation.
Comment: The judge’s comments provide some welcome guidance on the possible distinction between wilful misconduct and deliberate default. However, the judge was careful to make clear that his interpretation was particular to this contract. The courts might well take a different interpretation of the same words in a different contract. When drafting an exclusion clause:
- In order to be certain that a carve-out covers both intentional and reckless defaults, the safest course is to use the phase “wilful misconduct”.
- If you intend to carve-out from the caps on liability defaults committed intentionally, but not those committed recklessly, then using the phrase “deliberate default” might (but will not necessarily) achieve this. A safer course would be state expressly that liability for defaults committed recklessly fall within the liability caps.
Allegations of repudiatory breach
The Court dealt swiftly with Atos’s claim against De Beers for repudiatory breach. Although De Beers had breached the contract by withholding payment, this was not sufficiently serious to amount to a repudiatory breach.
The Court then turned to Atos’s conduct. Atos had an express right to suspend performance for non payment “until such time the due amounts are paid to the Supplier”. The court’s view was that Atos had not exercised this right at all. Instead, Atos had threatened to suspend performance unless De Beers agreed to vary the commercial terms of the contract. In so doing, Atos had made clear that it was not prepared to continue to perform under the existing contract. This amounted to an anticipatory repudiatory breach, which entitled De Beers’ to treat the contract as at an end.
Comment: Any contractual right to suspend performance should be exercised with care. For example, before exercising a suspension right, it is important to ensure that the relevant trigger has occurred. Any process specified in the contract should be followed to the letter and it is essential that the boundaries of the right to suspend performance are scrupulously observed. Atos’s downfall was that it over-reached and used the threat of suspension as leverage to re-open negotiations.
Damages
In assessing damages, the Court had to determine whether De Beers was entitled to claim the cost of buying a replacement system, even though De Beers had failed to show that it intended to do so.
The Court referred to a 2010 High Court decision: Van Der Garde v Force India [2010] EWHC 2373 (QB). In that case, the court considered in detail leading construction law cases and concluded that there was no authority that a claimant had to have purchased replacement services or shown an intention to purchase replacement services as a pre-condition to recovering damages for a failure to provide services.
The court held that, where there was substantial non-delivery of services (as in this case), then De Beers was entitled to recover the cost of purchasing replacement services, unless it would be unreasonable to do so. In assessing “reasonableness”, it didn’t matter whether De Beers actually intended to buy replacement services. The relevant question was whether it would be reasonable for a person in De Beers’ position to purchase the services. The court decided that it would be reasonable and so allowed De Beers’ claim.
In order to arrive at a figure that reflected De Beers’ “loss of bargain” the court then off-set against those damages all the costs that De Beers would have incurred, had the contract been properly performed. The Court therefore deducted the remaining payments due under the contract, the cost of agreed change requests and an amount to reflect claims brought by Atos that De Beers would likely have settled.
Comment: In this case, at the time the contract came to an end, Atos had failed to deliver any useable software to De Beers. The judge allowed De Beers’ claim for the cost of replacement services on the basis that Atos had substantially failed to deliver and it was reasonable to award damages on that basis. Where a supplier has partially delivered (or delivered a defective system), the courts may well apply other measures of damages - for example, an amount based on the difference in value between what should have been delivered and what has actually been delivered. This will depend on the facts and what, in the relevant context, is a “reasonable” approach.
Emily Parris, Senior Associate at Fieldfisher