Olswang partner Jonathan Choo
Olswang associate Shaun LeeOlswang Singapore-based partner Jonathan Choo and associate Shaun Lee examine governance and change control procedures in outsourcing contracts in this second fascinating post in their Technology and Outsourcing Hot Spots Series.
This knowledge partnership article follows November?s piece discussing pre-contractual negotiations in tech and outsourcing contracts.
Outsourcing contracts anticipate a fairly long-term relationship between the parties that is generally measured in years. Given such lengthy time frames, change is nearly inevitable in the form of the customer?s technological and business needs. Therefore, there needs to be a system / process in place to allow parties to make periodic changes to the agreed work scope in a manner that is structured and which minimises disputes.
The need for effective cooperation and governance
There is no standard outsourcing agreement that adequately suits all scenarios and business needs. Outsourcing contracts can operate in a number of forms depending on what the customer wants from the outsourced arrangement. This can range from simple cost savings, to allowing businesses to focus on their core competencies, to obtaining real improvements (expertise and scalability) in the area outsourced.
Regardless of the outsourcing arrangement entered into, effective governance, whether of an IT project or IT outsourcing, is crucial.
The case of Compass Group UK and Ireland Ltd (t/a Medirest) v Mid Essex Hospital Services NHS Trust, [2012] EWHC 781 (QB) provides an example of how a failure to cooperate in good faith and an overly aggressive insistence on strict contractual performance can destroy an effective business relationship.
Medirest entered into a contact with the defendant Trust for Medirest to provide facilities management, including catering services to the hospital. Under the terms of the contract, in return for services rendered in accordance with the Service Level Specification, the Trust agreed to pay the Contract Price (on a yearly basis and subject to indexation). The agreement also provided for the parties to cooperate with each other in good faith and to take all reasonable action as was necessary for the efficient transmission of information and instructions and to enable parties to derive the full benefit of the contract (see paragraph [23]).
The High Court held that such a general obligation to cooperate in good faith accorded with commercial sense, especially in the context of long term contracts (see paragraph [25] and [27]).
However, from an early stage (barely a week into the contract) the Trust's commercial director took a "challenging" and unhelpful approach to the way the contract was performed by Medirest. Severe financial penalties were imposed for minor infractions and the High Court held that these ?were patently absurd? and displayed a lack of ?fact and common sense? (see paragraph [85]).
For example, a single box of out of date ketchup attracted 30,860 service points and a deduction of ?46,320 (to put this into context, the contract provided that service failure points of more than 1,440 justified a termination of the contract by the Trust).
The English Court considered that the effect of the Trust?s conduct was to damage, and ultimately to destroy, the working relationship with Medirest.
Lack of effective service descriptions
In the case of Vertex Data Science Ltd v Powergen Retail Ltd [2006] EWHC 1340 (Comm), one of the major problems encountered by the parties involved in the outsourcing arrangement was a fundamental disagreement as to the respective parties? obligations. This was the result of a lack of effective service level descriptions within the outsourcing agreement.
The High Court noted that there was ?a fundamental question whether Powergen [could] legitimately complain about, or regard as non-contractual, a level of service which, whilst not in accordance with the Regulations and Good Industry Practice to which, by clause 4.2.1 of the MSA, Vertex must adhere, [was] nonetheless not actually in breach of a Service Level Agreement (?SLA?) because the SLA lack[ed] a criterion which measure[d] the relevant shortcoming in performance" (see paragraph [21]). The High Court also noted that, ?[i]t [wa]s perfectly possible that the terms of the SLAs permit[ed] a level of performance which [wa]s, objectively, unsatisfactory" (see paragraph [38]).
In fairness, the parties did try to resolve their disputes. The High Court decision detailed a series of near-monthly meetings between the parties, at the operations level up to management level in an attempt to resolve these disputes. However, parties were ultimately unable to resolve their differences, in part because of a failure to specify the parties' obligations.
Change control procedure ? Catering for business and technological change
As mentioned, a customer?s requirements, however well specified, will likely evolve over time. In those circumstances, it is important that the contract provides for a framework and mechanisms that would allow parties to determine and effect the necessary changes whether to the design, quality, quantity or costs of the project. For example, in cases of long term IT projects and outsourcing contracts, issues of technology replacement and technology refresh might arise which affect all four criteria.
One important mechanism is benchmarking provisions, which can have the dual benefit of keeping pricing and performance competitive.
However, in a complex outsourcing agreement, benchmarking itself could prove to be a costly endeavour with the result that the expense of conducting benchmarking outweighs its benefits. For example, when performance targets run into the hundreds, gathering and analysing the data to determine if such targets have been met will inevitably be costly. In such circumstances, parties might wish to consider either reducing the number of performance targets, or committing to review such targets on a sample basis.
Parties also need to have mechanisms in place in order to allow changes to the scope of work. In the absence of a contract change (or variation order) clause, a vendor is (at least under common law) only obliged to perform what is stipulated in the contract. The customer is not entitled as of right to direct variations, whether to amend or increase or decrease the scope of work.
Conversely, a proper variation order clause will ensure that the vendor is paid the agreed contractual price as opposed to a fair market value (or quantum meruit basis) for a properly directed variation. Similarly, a proper variation order clause should provide for attendant effects like delay.
Changes can be good, neutral or even detrimental to the project. It is advisable for all stakeholders to have an opportunity to participate in the control of any changes. A change control procedure should therefore anticipate the possibility that a change is rejected. Hence, it may be necessary for parties to adopt processes which will help them to identify reasons for the changes, to investigate the impact of such changes (including attendant costs and delays) and to review those changes in light of the likely impact of such changes.
A contractual provision that occasionally finds its way into such contacts is an agreement to negotiate certain changes in good faith. This is despite the fact that such provisions are generally unenforceable under English law as per the House of Lords decision in Walford and Others v Miles and Another [1992] 2 AC 128. Such agreements, like agreements to agree, are unenforceable because they lack the necessary certainty as to their terms.
Nevertheless, a number of commonwealth jurisdictions (New South Wales and Canada) have departed from that strict position to give some effect to such provisions in certain circumstances. The recent Singapore Court of Appeal decision of HSBC Institutional Trust Services (Singapore) Ltd (trustee of Starhill Global Real Estate Investment Trust) v Toshin Development Singapore Pte Ltd, [2012] SGCA 48 clarifies that where parties are already in a contractual relationship, the court will not simply render an agreement to negotiate in good faith unenforceable. More details of this case can be found in a previous post.
However, this does not mean that the courts can be called upon to ensure that parties actually come to a result. Instead, the role of the courts is simply to ensure that parties abide by their contractual obligations. If there is an unremedied breach of an obligation to negotiate in good faith and parties come to a negotiated result, then the prejudiced party may seek the court?s assistance in voiding that result.
Nevertheless, there are real limitations to this approach. In the event that parties are unable to come to a negotiated position despite having negotiated in good faith, the Singapore courts will not determine that dispute for them and impose a result on parties. In the event that parties prefer for the business relationship to continue, they would be well advised to have some binding mechanism that is capable of breaking the deadlock.
Conclusion
The execution of technology and outsourcing contracts presents a host of interesting issues by virtue of the length of their tenure and the extent of cooperation required between the parties.
Compounding the problem is the tension between the specificity of service level obligations (or benchmarking provisions) to ensure that the customer gets what it actually wants, and the costs of monitoring and enforcing those provisions in large and complex contracts.
The importance of effective governance cannot be overstated. Effective governance structures allow parties to highlight, ventilate and escalate issues and problems before those become intractable and jeopardise the entire agreement.
Nonetheless, such structures and processes cannot be panaceas. To borrow a phrase from the judgment in Medirest, the key to ensuring a successful business relationship is ultimately to have the right people in those governance structures ?deploy[ing] fact and common sense?.
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Jonathan Choo is a Partner and Head of Arbitration & Dispute Resolution at Olswang Asia LLP. Shaun Lee is an Associate; Arbitration & Dispute Resolution at Olswang Asia LLP.
Olswang Asia, based in Singapore, is a full service law firm particularly focused on advising businesses in the Technology, Media and Telecoms industries. For enquiries or further information, please email This email address is being protected from spambots. You need JavaScript enabled to view it. , or contact Olswang Asia at +65 6720 8278.
Check out Olswang?s Singapore International Arbitration Blog at http://singaporeinternationalarbitration.com/
Source: http://www.legallyindia.com/Tech-Media-Comms/technology-outsourcing-contracts-governance-control-change
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