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Let's call the whole thing off – outsourcing exits

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Let's call the whole thing off – outsourcing exits

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This article was first published in the December 2011 issue of Outsource Magazine

Nobody wants a relationship to end acrimoniously – but without an understanding of what to do if things do fall apart, there could be tears aplenty…

Most of us sometimes grapple with exits from outsourcing relationships. Yet despite a wealth of experience surrounding termination, it is not uncommon for deals to end acrimoniously. If relationships are deteriorating, it is easy to act first and regret later.  Without a clear understanding of your rights, mistakes can be easy to make.

I just need some time to myself

One way to deal with a breakdown in relationships is to call for time out. Either the customer suspends payment or the supplier suspends performance.  However, it is a common mistake to think that a party has an automatic right to suspend a contract. Take this passage from Channel Tunnel v Balfour, 1992 in the Court of Appeal:

“It is well established that if one party is in serious breach, the other can treat the contract as altogether at an end; but there is not yet any established doctrine of English law that the other party may suspend performance, keeping the contract alive.”

If you have a specific suspension right written into the contract, then you’re on safer ground – but only if you exercise your right properly.  In Atos v De Beers, 2010, Atos was suffering costs overruns and delays. As a result, De Beers withheld payment. Atos then suspended work, relying on their contractual right to suspend for non-payment.  However, Atos overstepped the mark. They threatened to suspend work not just until payment was made but until De Beers agreed to pay an additional £4.6 million, to move to time and materials charges and to waive claims against Atos. The judge concluded that Atos had no intention of seeing through the contract as it was written, and thus was in breach of contract allowing De Beers to terminate.

So, a party which has contractual suspension rights must take care to act within its rights and not to seek additional advantage as a condition to recommencing performance.

You’re not the person you used to be

Another possibility as relationships decline is that the customer reassesses its strategy and no longer wants to deal with the supplier. Although the contract may allow the customer to terminate for convenience, this might be linked to unattractive termination costs. Waiting until the contract expires can be equally unappealing. A frequent solution customers hit on is to search hard for a breach of contract which would allow termination. This does not always end well, however, as was shown in the case of Southwark London Borough Council v IBM, 2011.

Southwark hired IBM to provide some of the tools needed for a new data management system, with other tools coming from Orchard. A new Data Integrity Manager was hired by Southwark part way through the project.  She did not favour the Orchard software and was more familiar with other solutions. So she set about rewriting the requirements, claimed IBM could not meet the new requirements and closed down the project. Then, Southwark threw the book at IBM accusing them of misrepresentation, negligence and breach of contract.

Over the course of the trial, Southwark’s case unravelled. Southwark did not bring some key witnesses.  Every email was pored over, revealing that not everyone at Southwark thought IBM was at fault, and that IBM had been clear about the capability of its solution.  In a matter of days, Southwark’s case collapsed.

The lesson is that if you do want to get out of a contract you must carefully and dispassionately review the situation. Trying to engineer an exit can end in disaster.

I’m leaving you my dear

Of course another possible way out is to terminate for material breach.  Even here, caution is advisable.

The big mistake is to terminate and then discover the breach was not so material. This might be a wrongful termination entitling the other party to damages.

A second concern is that most contracts allow 30 days’ notice for a breach to be remedied. The case of Schuler v Wickman, 1974 concluded that the breaching party need not turn back the clock to remedy the breach, but should put things right for the future. In Peregrine v Steria 2004 it was suggested that this means putting the other party in the position it would have been in but for the breach, and the court suggested compensation might do the trick.

There is more case law which builds the picture, but what should be clear is that frequently the courts will allow the party in breach to redeem itself if there is a remedy period in the contract.

This is goodbye

The most black-and-white legal right of termination is to claim the other side has failed so fundamentally that it has shown it will not honour the contract, a so called repudiatory breach. If one party is in repudiatory breach that will entitle the other party to terminate and treat the contract as discharged.

But what of exit obligations? It can be ambiguous whether exit obligations will survive in these meltdown situations, even though there are good arguments why they should.  Practically, it may turn out to be difficult to compel a supplier to support transition beyond perhaps the basic hand over of customer materials.  Discovering the limits of your exit rights after termination is hardly great for business continuity.

As soon as termination is in mind, customers should assess their exit requirements and work out how to secure their operations, either through the contract or if necessary through contingency plans.

What should be clear from this article is that suspension, termination and exit can throw up complex and unanticipated problems.  However, with a considered and disciplined approach, it is possible to steer clear of the pitfalls and manage difficult circumstances to get to the right result.

For more information please contact Simon Briskman, Partner or Huw Beverley-Smith, Director in the Technology and Outsourcing Group at Field Fisher Waterhouse LLP.

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