Author: Tom Bolam
This article was published on The Society for Computers and Law on 2 June 2015.
Tom Bolam highlights the dangers of proceeding with IT projects without fully agreeing key terms and recording them in a binding agreement. He believes that, when considering IT contracts, lessons can be learned from the construction industry.
In 2002 the Government awarded contracts for ‘Spine’, the NHS National Programme for IT. Heralded by its implementation agency, NHS Connecting for Health, as ‘the world’s biggest civil information technology programme’, the concept was to create an electronic care record system for all patients that could be accessed securely by healthcare professionals. By 2011 the programme had effectively been shelved, the Public Accounts Committee described it as one of the ‘worst and most expensive contracting fiascos’ in the history of the public sector. The estimated costs of implementing Spine were initially set at £2.3 billion over a three-year period. By 2006 a National Audit Office report said that ‘Substantial progress has been made’ with Spine but estimated that the total costs of the project would be in the region of £12.4 billion. By 2010, the Daily Telegraph was reporting that officials involved in the project were saying privately that the total costs could be in excess of £31 billion.
The Spine debacle and other high profile IT project disasters, such as the BBC’s £100 million Digital Media Initiative, are easily dismissed as examples of public sector incompetence and mismanagement. Whilst it is true that many of the largest IT project disasters have taken place in the public sector, the private sector is far from immune. In fact, despite the publicity surrounding the Spine and the Digital Media Initiative, litigators are seeing an increasing number of claims arising out of ill-fated IT projects. Partly, this trend is a corollary of the ever greater reliance on IT to fulfil core business functions. As more businesses are involved in large-scale and complex IT projects, it is natural that there will be an increase in disputes and so litigation in this area. What is also apparent, however, is that many of the problems experienced by businesses are exacerbated by a failure to put in place even basic safeguards at the outset of complex IT projects. Many businesses still seem to deal with IT projects differently from other major investments despite the regularity with which IT projects turn sour.
To give a fairly typical example, we recently acted for a medium-sized software company in a dispute against a FTSE 250 retailer. This was the history: after a prolonged beauty parade lasting several months, the retailer identified our client as preferred IT provider to implement a new software system. The software in question could be used ‘off the shelf’, but the plan was to tailor the software to the particular requirements of the retailer and to ensure that the software could interface effectively with the retailer’s core IT systems. Large project teams were assembled on both sides, detailed plans and budgets were drawn up and an implementation timetable lasting 12-18 months was devised. After a significant down-payment by the retailer, work on the project began.
Six months later the project was in disarray. The retailer was experiencing serious IT problems elsewhere in its business and so could not afford to devote significant manpower to the project. Its project leader had left the company and his replacement was less enthused by the project than his predecessor. It had also become apparent that integrating the software into the retailer’s existing IT structure would not be as straightforward as had initially been thought. In short, the retailer decided that it could not proceed with the project. The problem it faced was that, in the rush to get the project started and draw up detailed implementation plans, the contract had been put to one side. Non-binding heads of terms had been agreed and a contract had been drawn up in draft, but no binding written agreement had ever been concluded. Both parties were aware of this but, as the project timetable and price had been agreed, the parties were not overly concerned by the lack of a comprehensive written agreement.
Without a proper contract in place, however, the retailer had no clear idea of the terms on which it could terminate the project or its potential liabilities if it were to do so. In the context of that uncertainty, the retailer concocted a series of purported breaches of contract by the software supplier to justify an early termination of the agreement. In addition, under pressure from its board, the retailer’s project team sued to recover the sums that it had expended on the project. Lengthy litigation ensued, ultimately costing the retailer more in legal fees and settlement payments than total cost of the software project, had it been completed.
It is easy to see the scenario described above as indicative of sloppy management and oversight. That may be so, but the practice of embarking on complex IT projects without first agreeing a comprehensive contract is far from unusual. The reasons are not hard to fathom. The procurement process for these types of projects can take months or years and requires significant investment. When a preferred provider is identified, the focus shifts to detailed project implementation planning. Once a plan has been devised and the project price agreed, there is an obvious desire to begin work immediately. The notion of delaying a project so that the finer details of a contract can be agreed is not a palatable option and many projects therefore commence on the basis of loose heads of terms, an agreed plan and standard terms and conditions until a detailed contract is agreed. Once work on the project has commenced, focus shifts elsewhere and the contract is neglected.
Delay and termination
What many businesses fail to appreciate is that IT projects require special contractual considerations, particularly because of the frequency with which such projects lead to disputes. In particular, it is often not properly understood that, if a project goes wrong, in the absence of clear contractual termination provisions, a customer may have no right to terminate the contract even in the face of poor performance by the IT provider. This is particularly true in relation to the problem of delay.
It is trite to observe that IT projects often fall behind schedule. Often the cause of delay can be a matter for heated debate, but consider a hypothetical situation where it is clearly the IT provider who is at fault for a delay. Most complex IT projects will have a project timetable, even if there is no detailed written contract. Rarely will it be the case that the time for delivery of an IT project is of little consequence to the customer, and an IT provider will usually be made aware of the critical importance to the business of the project being delivered on time. In our hypothetical scenario, there is a written contract setting out project milestone dates and a clause providing that the software provider must use ‘reasonable endeavours’ to achieve those milestones. Project completion is six months after commencement. Some 12 months after commencement the project has still not completed. It has become apparent that the project is more complicated than the IT provider had contemplated and completion may take another 12 months. In that context, it would be natural for the customer to assume that it can cut its losses, terminate the contract with the IT provider and sue for damages. However, in the absence of a clear contractual provision entitling the customer to terminate in those circumstances, the reality may very well be that the customer has no right to terminate whatsoever.
One might reasonably think that a delay of this magnitude must constitute a repudiatory breach of contract, entitling the customer to terminate. On the basis of the recent Court of Appeal decision in Ampurius Nu Homes Holdings Ltd v Telford Homes (Creekside) Ltd  EWCA Civ 577, this assumption is misplaced. In Ampurius, Telford Homes had agreed to use reasonable endeavours to complete the construction of some buildings by early 2011. Once completed, Telford Homes would grant Ampurius Nu Homes a lease for a term of 999 years. The project was delayed, primarily because Telford Homes was in financial difficulties. By October 2010 it became clear that construction would not be completed by early 2011. Ampurius Nu Homes, in the mistaken belief that Telford Homes had abandoned the project altogether, claimed that there had been a repudiatory breach of contract and it was entitled to terminate.
The matter went to trial and at first instance the court found that, but for the termination of the contract by Ampurius Nu Homes, Telford Homes would have completed the construction of the buildings around one year late. This constituted a repudiatory breach and Ampurius Nu Homes had therefore been entitled to bring the contract to an end.
On appeal, the decision was overturned. The Court of Appeal held that there had been no repudiation. In his judgment, Lord Justice Lewison advocated a two-stage test when considering whether there has been a repudiatory breach of contract. First, the court should, ‘consider what benefit the injured party was intended to obtain from the performance of the contract’ (at ). Stage two was to consider, ‘the effect of the breach on the injured party. What financial loss has it caused? How much of the intended benefit under the contract has the injured party already received? Can the injured party be adequately compensated by an award of damages? Is the breach likely to be repeated? Will the guilty party resume compliance with his obligations? Has the breach fundamentally changed the value of future performance of the guilty party’s outstanding obligations?’ (at ).
Applying these considerations, the court found that a delay of one year in completing the works could not be seen as depriving Ampurius Nu Homes of substantially the whole benefit of or frustrating the contract when the overall objective was to grant a 999 year lease. A delay, ‘will only become a repudiatory breach if and when the delay is so prolonged as to frustrate the contract. In the context of an agreement to grant a series of 999 year leases, we are a long way from that in this case’ (at ).
Ampurius was considered by the Court of Appeal and approved in Urban 1 (Blonk Street) v Ayres  EWCA Civ 816. In Urban 1 the Court of Appeal also made clear that a party cannot simply serve a notice to make time of the essence: ‘Statements in many of the cases and some textbooks that the service of a notice to complete makes time of the essence in equity are incorrect. Absent any relevant express provisions in the contract… it is contrary to all principle for one party to be able unilaterally to transform one type of contractual provision (namely, an innominate term or a warranty in the strict sense) into something different’.
When the principles set out in Ampurius are applied to, for example, a project to develop software, integrate it into a customer’s existing IT system and then grant a perpetual licence to use the software, the risks of not clearly setting out the rights of the customer in the event of delay are clear. The objective of the contract in these circumstances is to grant the customer a perpetual licence. The benefit of that licence will, of course, not subsist for 999 years, but it is likely that the customer will intend to use the software for an indefinite period. In that context, a delay of months or even a few years may not be seen as depriving the customer of substantially the whole benefit of the contract. Without an express contractual right to terminate in the event of delay, the customer may be left in the unenviable position of having to pay-off the IT provider in full if it wants to abandon the project.
Avoiding the courts
Aside from delay, one of the most common causes of disputes in large IT projects is the attribution of blame for escalating costs. Often the reasons for increased costs are multifarious and highly technical. Disputes of this type are not really suitable for determination by the courts. The costs of cases involving complex expert evidence are very high and the funeral pace of most court proceedings makes a speedy resolution unlikely. This latter issue is a particular problem in circumstances where parties do not wish to abandon a project but want the costs of an overrun allocated quickly so that the parties can move on.
A neat solution to this problem can be borrowed from the general practice in the construction industry. There is no reason why parties cannot agree that disagreements between them about contractual performance be dealt with by way of adjudication. Adjudication can take many forms but in principle it is a streamlined dispute resolution mechanism whereby parties make limited submissions to an expert adjudicator who can then make a quick ruling. The parties can decide in advance whether the decision is appealable, how long the adjudication process will take and on the identity of the adjudicator. An expert adjudicator with experience in the industry will very likely be in a far better position to understand which party is likely to have been at fault than a High Court judge.
Setting out clear consequences of delay and the method by which parties must resolve minor disputes are just two of the points that should be dealt with in a binding contract before embarking on any substantial IT project. The pitfall to avoid is to start work on a project on the basis of a project plan and heads of terms with an intention to agree the detailed contract at a later date. Aside from the problems identified above, a customer is in a far weaker position to negotiate a contractual term such as a right to terminate for delay if work on the project has already begun. It may not be possible to agree on every last detail before work begins, but there is never any excuse for parties not to agree most of the key terms and record them in a binding agreement at the outset.
Most IT projects will not prove to be a disaster quite on the scale of Spine, but IT projects do, like construction projects, frequently veer off course. Commercial parties engaged in complex IT projects need to start learning the lessons from the construction industry and plan for the worst case scenario as a matter of course.
Tom Bolam, Associate, Fladgate LLP (email@example.com)