Large IT contracts and outsourcings are rarely all smooth sailing. There will often be problems along the way. Some problems will be comparatively small and manageable, dealt with adequately through robust governance structures and effective contract management. Larger problems may arise which require senior management involvement, possibly a renegotiation of the contract and a resetting of expectations.
However big or small the problem, it is generally neither cheap nor easy for one party to terminate and walk away - no matter how good their contract and how strong their contractual position.
As a result, companies often find themselves in a position where they have a right to terminate, but are reluctant to exercise that right if there is any way to resolve the issues and move forward.
The scenario …
A supplier over-promised and has consistently under-performed. The project is late, over-budget and key functionality still doesn’t work. You have followed governance procedures, varied the contract to give the supplier more time and money, escalated to senior management and finally … and reluctantly … issued a breach notice requiring rectification within the requisite notice period.
The supplier is unable to remedy within the specified timeframe.
So you have a right to terminate …
A contractual right to terminate for breach gives the non-breaching party the choice between continuing performance of the contract, or termination.
It is an election that can be made by the non-breaching party.
The non-breaching party must elect between two inconsistent rights - either to terminate the contract or to affirm it and insist on further performance.
It follows that the non-breaching party may lose the right to terminate if its conduct is inconsistent with the exercise of its right to terminate. The innocent party may, by its conduct, “waive” the right to terminate. Even if there is a contractual provision which seeks to preserve rights from waiver (for example, in circumstances of delay or failure to enforce rights) - the nature of termination as an election between inconsistent rights, means that a party may, by its actions, affirm the contract and waive its rights, notwithstanding that provision.
So what is required to affirm the contract …
As a general rule, an election to affirm a contract is inferred from unequivocal words or conduct that are consistent only with the continued existence of the contract.
An express election, or intention to elect, is not required.
An express disclaimer will not preserve a right to terminate if in fact the party’s conduct is inconsistent with termination. Legal words can assist if conduct is not conclusive or could be interpreted either way. However, legal words will not override conduct which is inconsistent with termination.
Having said this, not every act consistent with the continuation of the contract will be conduct amounting to an election to affirm, and this is particularly the case where that conduct is also consistent with the reservation of a right to terminate.
The issue in large IT contracts and outsourcing agreements, is that generally the innocent party will not want the supplier to “stop work” while it decides whether or not to terminate. It may wish to continue to negotiate with the breaching party to reach a solution. In any event, it may require the ongoing performance of the services for business continuity.
So what can you do …
Planning - Issuing a notice to remedy is often an important step in escalating problems with the other side and may prompt negotiations or mediation. However, issuing a notice to remedy should be part of a larger overall plan. You should have a strategy which covers circumstances where the breach is not remedied, and an understanding of whether or not you do want to terminate.
Limit delay - Do not unnecessarily delay in making the decision to terminate. While the courts accept that a party may need reasonable time to consider its position and the merits of alternative courses of action, a party cannot unduly delay in making a decision. This is particularly the case if the delay is likely to prejudice the other party. There is no hard and fast rule - a week, a month, three months - what is reasonable will depend on all of the circumstances.
Clear reservation of rights - Be clear in any communications with the defaulting party that you are reserving your right to terminate and are considering your options. A reservation of rights will not protect you if there is clear conduct which is inconsistent with termination. However, it will help to clarify your intentions and reserve your rights in circumstances where conduct could be interpreted either way.
Affirmation - Be wary of continuing to exercise rights under the contract, or insisting on performance by the other contract party, as this is likely to be viewed as an affirmation of the contract.
What may be seen as affirmation …
Whether or not a party has affirmed the contract will be a question of fact based on the particular circumstances.
To remove the risk of affirmation, ideally you would not undertake any activities under the agreement until a decision has been made. This may work in sale contracts or contracts with a few key obligations. However, in ongoing service contracts, outsourcing agreements and complex IT projects, this may be difficult or impossible without risking serious business interruption.
In these circumstances, it is important to avoid conduct that is consistent only with the continued operation of the contract. Issuing new work orders, signing change control orders, and agreeing to project plans for delivery of other aspects of the project are examples of conduct which may be considered as consistent only with the ongoing operation of the contract and should be avoided until a clear decision has been made.
A key factor will be ensuring that everyone involved in the relationship is aware of the issues and has instructions on how to proceed. If the lawyers have sent a letter to reserve your rights, but the project manager is issuing work orders, this conduct may well be seen as affirmation depending on the circumstances.
What if you get it wrong …
If you purport to terminate in the face of conduct amounting to an affirmation of the contract, you may be considered to have repudiated the contract and be liable for damages arising out of the wrongful termination.
This is exactly what happened to a company in the UK recently.
The case in question is Tele2 International Card Company v Post Office Limited, a 2009 decision of the England and Wales Court of Appeal. In this case, a party (Post Office) was found to have a clear right to terminate for a failure of the other party (Tele2) to provide a parent company guarantee. It was common ground between the parties that this failure was a material breach giving rise to a right for Post Office to terminate the contract.
However, Post Office continued to carry on business in accordance with the contract and it was 11 months later when it purported to terminate the contract relying on the failure to provide the parent company guarantee.
The continued performance during this period, without protest about the breach or reservation of rights, was held to be affirmation of the contract. This was the case even though there was a provision which stated that a delay in the exercise of a right would not be a waiver of that right.
Given that the contract had been affirmed, when Post Office stopped performance in reliance on its notice to terminate, it was found to have repudiated the contract.
The failure to complain about the breach, or to reserve the right to terminate, were important in this case.
However, it is important to remember that notification of the breach and a reservation of rights, will not preserve rights in the face of clear conduct which is only consistent with affirmation of the contract. A well drafted letter reserving rights will only get you so far. It will not protect you from lengthy delay and continued performance and enforcement of the contract, as that conduct is likely to be considered conduct which is only consistent with an election to affirm.
And the lesson is …
Don’t lose the right to terminate due to corporate indecision.
Have a plan, exercise it promptly, and beware of affirming the contract while the corporate wheels are turning.