Technology and Outsourcing Hot Spots (1): Pre-Contractual Negotiations

Part 1 of our technology and outsourcing hot spots series discusses some of the more relevant issues relating to pre-project scoping and in particular:

  • the need to be explicit in setting out the scope of work;
  • issues of marketing puff;
  • pre-contractual misrepresentations;
  • entire agreement clauses; and
  • limitation of liability.

In an ideal competitive bid system, the customer will set out a request for proposal which should clearly set out the requirements of the project (especially where a requirements analysis has been completed). In turn, the vendor/supplier will (hopefully) have accurately set out its capabilities and resources as well as the time and cost required to execute the project. There will likely be a series of exchanges as the customer seeks clarifications from the vendor / supplier. Eventually, the parties will then enter into an agreement which should accurately capture the scope of work as well as the obligations of the vendor in delivering that project and any subsequent service levels. These will be based on the initial requests and subsequent replies and clarifications.

Alternatively, a customer may approach a consultancy or IT firm to evaluate and propose a solution to their IT needs, which can take the form of an enterprise wide ERM, managed services / outsourcing of non-core functions. Typically, the IT consultancy firm will rely on the representations of the customer to determine what the customer needs and what can be delivered in terms of a solution. There might subsequently be a pitch document followed by a more detailed document setting out the proposed solutions etc. Parties will then enter into a contract to formalise the scope of work and obligations in the form of deliverables and/or service levels on the part of the vendor/supplier.

Clearly, prior to the formation of the contract, representations are already being made at every stage from customer to vendor and vice versa, whether as to the scope of work or as to the capabilities of and resources available to the vendor/supplier. Both sides will rely on those representations in coming to their decision to enter into a contract. Problems arise when representations which are made (and which parties rely on), do not find their way into the final agreement.

Parties should note at the outset that they might be liable for those representations made negligently or fraudulently, whether under statute (e.g. the Misrepresentation Act), or under common law. The test under common law for negligent misstatement or misrepresentation in essence involves (a) proving that the loss suffered by the claimant was factually foreseeable; (b) the assumption of responsibility by the defendant; (c) reliance by the claimant on the defendant representation; and (d) there being no reason to displace that duty of care owed by the defendant to the claimant.

There is an extensive range of representations which may be classified as mistatements. On one end of the spectrum, this involves representations that are negligently, even fraudulently made. On the other end, it might involve statements that the law does not consider to be representations at all. For a statement to be an actionable representation, it has to be a statement of fact as opposed to opinion or mere advertising puff. To the extent that a party relies on those statements, they are not actionable.

A review of some recent prominent infocomms disputes highlights the problems such pre-contractual representations can create. Failures can be very costly.

The Costs of Failure and Litigation

In BSkyB Ltd & Anor v HP Enterprise Services UK Ltd & Anor [2010] EWHC 86 (TCC), the project in question was to (a) integrate four legacy systems into a single customer relationship management system and (b) deliver a new customer contact centre as well as refit existing ones owned by BSkyB within a period of 12 months. However, BSkyB took 5 of those 12 months issuing a request for tenders and evaluating those tenders. Eventually, it was tendered to HP at the sum of about £47.6 million (which represented a so-called baseline budget) in August 2000. Problems immediately arose and the project was delayed a number of times while its costs escalated. The project was only eventually completed in a more limited version on 31 March 2006 and at a cost of £265 million to BSkyB.

BSkyB eventually sued for £709 million in damages including lost revenue and profits lost due to the delays. The trial itself started in October 2007 but only ended in July 2008. Expert evidence on IT technical issues took a month, followed by 3 months of expert evidence on the amount of damages. The final decision ran to 450 pages and interim damages of £270 million were awarded. HP eventually settled at £318 million inclusive of legal costs

In the Singapore case of PT Panasonic Gobel Indonesia v Stratech Systems Ltd, [2009] 1 SLR(R) 470, the dispute involved the failed migration by Stratech, a Singapore mainboard listed IT and consultancy firm, of Panasonic’s legacy system to a ERM system which involved the concurrent operations of a finance and distribution system module, a purchase sales and inventory system module, a customer service management system module as well as a human resource management system module. Stratech was eventually found to be in breach of the service agreement for the provision of the integrated system.

Notably, Stratech had itself pitched the system following a consultancy study that it had conducted for Panasonic. The negotiations of the service contract took 7 months (between May and November 2011) in part due to an agreement in August 2011 to incorporate more modules into the integrated system. The total cost of the project was $2,766,000.

Work started in November 2011 and completion was meant to be in August 2002. However, in June 2002, Stratech asked for a two month extension which was eventually acceded to on the basis that it would complete the project at no extra charge. Completion still had not taken place in October 2002 and only 2 modules were in operation. Even as late as July 2003, the entire system still had not gone live and there were persistent complaints about the 2 modules that had. The one attempt for the integrated system to go-live had to be terminated after 9 days for fear that the entire system would crash.

At this stage, in anticipation of a second go-live attempt for the integrated system, Panasonic then engaged PwC Indonesia to evaluate and analyse the problems with the system and whether it could be salvaged. PWC estimated that an additional US$400,000-US$600,000 worth of man-hours and US$150,000-US$250,000 worth of hardware would be required to complete the implementation of the integrated system.

In turn, Stratech proposed its proposal to re-test and re-launch the system and stated that it required an additional payment of S$1,435,840 as well as payment of the balance amount of the contract sum. Panasonic paid the balance but Stratech never recommenced work due to a dispute over subsequent payment terms.

Issues of pre-contractual negotiations and representations – entire agreement clauses

Entire agreement clauses assist in promoting certainty as they define and confine parties’ rights and obligations within the so-called four corners of the contract. However, pre-contractual negotiations and representations that do not find their way into the written contract are thereby not enforceable.

A typical entire agreement clause follows:

The Contract constitutes the entire agreement between the parties and sets out a full statement of the contractual rights and liabilities of X and Y in relation to the Works, and no negotiations between them nor any document agreed or signed by them prior to the date of execution of the Contract in relation to the Works is of any contractual effect

In the Panasonic v Stratech case, the pre-contractual negotiations and representations were material as Panasonic was taken in by so-called marketing puff certain documents presented to Panasonic. According to Panasonic, Stratech represented that this new system would automate all those processes and would work in real time as well.

The law does not consider marketing puff to be actionable representations. In such cases, the court considers that “[e]ulogistic commendation by a salesman of the wares that he touts is a common and expected feature of the market place. Courts are therefore reluctant to rescind contracts of sale merely on account of the exuberant and exaggerated language employed by salesmen. This reluctance is reflected in the maxim ‘Caveat Emptor’ or ‘Buyer Beware’” (see paragraph [27] of Panasonic v Stratech).

As a result, while Panasonic was expecting a system that would allow it to access its information within the new system “in near real time and instantaneously“, the system eventually delivered could not do so. Furthermore, it had no remedy as a matter of misrepresentation.

Critically, the learned judge stressed that to the extent that any representation did exist but which did not find its way into the contract, such a representation could not be relied upon by the representee. This was because the entire agreement clause(s) in the Services Agreement made it clear to both parties that their obligations were contained entirely within the written agreement. To the extent that the customer wanted a pre-contractual representation to have contractual force, the onus was on the customer to ensure that it found its way into language in the written agreement.

While the High Court was receptive to the argument that an entire agreement clause could not operate so as to release one party from the effects of having made an actionable misrepresentation, nevertheless, that issue had not been definitively decided and did not have to be decided as the statements that Panasonic sought to rely on were not actionable representations. (see paragraph [46])

Similarly, the crux of the BSkyB case turned on certain representations made or alleged to have been made by one of the vendor / supplier’s personnel and what those representations meant. The judge eventually decided that the vendor’s representative had oversold the project and promised timelines which were what the customer wanted to hear rather than having some reasonable basis for those timelines. The vendor’s representative had in fact made those representations despite the vendor’s technical team telling him that it could not be done and urging him to be more realistic about the timelines. This knowing falsity and/or reckless disregard for the truth caused his representations to be fraudulent rather than merely negligent.

Furthermore, the High Court found an instance of negligent misstatement on the vendor’s part in 2001 in that the vendor had negligently misrepresented that it developed an achievable plan, which had been the product of proper analysis and re-planning.

However, the English High Court rejected BSkyB’s other two arguments of misrepresentation. First, the manner in which baseline budget was incorporated in and formulate in the contract did not constitute a representation that the project could be accomplished in that budget nor that the vendor had represented that a proper estimate of costs to be incurred had been made in relation to the baseline budget.

Second, there was no misrepresentation in relation to the vendor’s resources, both in terms of availability and readiness to start the project, and in terms of skills and experience. The High court found that either no representation was made by the Vendor or that the vendor had reasonable grounds for making such representations or that any breach of the vendor’s representations was not material. The net result was that there was no cause of action for BSkyB for misrepresentation on these grounds.

Once again, an entire agreement clause was relied upon to exclude HP’s liability for pre-contractual misrepresentations. However, the difference here was that the English High Court took the position that the mere reference to representations in the entire agreement clause was insufficient to exclude liability for negligent misrepresentation. The learned judge held at [387] that,

“While there is reference to representations, there is nothing in the clause that indicates that it is intended to take away a right to rely on misrepresentations… I consider that clear words are needed to exclude a liability for negligent misrepresentation and that this clause does not include any such wording. As [BSkyB] submit exclusion clauses are construed strictly and clear expression is needed to exclude liability for negligence”.

Limitation of Liability

Apart from entire agreement clauses, limitation of liability clauses are another important boilerplate clause used by vendors to limit their liability to the customer should issues arise. As the name suggests, such clauses are meant to limit the liability on the part of a party, invariably that of the vendor / supplier to a specific quantum or a calculation thereof regardless of the actual losses suffered by the customer. Limitation of liability clauses are also drafted to exclude certain heads of damages, mostly relating to indirect and consequential damages such as loss of goodwill, loss of business, loss of anticipated profits or savings etc.

Examples of typical limitation of liability clauses follow:

Neither party shall be liable to the other for any indirect or consequential loss (including but not limited to loss of goodwill, loss of business, loss of anticipated profits or savings and all other pure economic loss) arising out of or in connection with this Agreement“;

and/or

If Party X shall be found liable in damages under this Agreement, under no circumstances shall Party X be liable to Party Y for any amount in excess of the price of the Works i.e. $Z

In a previous post, we discussed the issue of limitation of liability clauses. Limitation and exemption clauses are to be construed strictly – if a party seeks to exclude or limit his liability, he must do so in clear words. A court cannot, however, reject an exemption clause if the words are clear and unambiguous and susceptible of one meaning only. Furthermore, courts will use the contra proferentum rule that contractual provisions should prima facie be construed against the party who was responsible for the preparation of the contract and/or who is to benefit from the provision. In this respect, it is presumed to be “inherently improbable” that parties have agreed to bear the liability for the acts of another (negligent or otherwise) unless that is set out in clear and unequivocal terms.

This approach also applies to indemnity clauses whereby one party agrees to “hold harmless” another party’s loss. The court will read such clauses restrictively where the effect of the indemnity clause is that it would limit or exclude one party’s liability to another.

It should also be noted that even in commercial transactions between two business entities, the Unfair Contract Terms Act (Cap. 396) could apply such that any such limitation or exculpatory clause will be subject to the reasonableness test.

In the cases mentioned above, Stratech managed to limit its liability under a limitation of liability clause to a sum of S$1,830,000 (having been paid $2,766,000). In contrast, HP was unable to do so because their limitation of liability clause was held not to cover fraudulent (or even negligent) misrepresentations. As a result, HP was unable to rely on the limitation of liability clause to limit its liability to a “mere” £30 million but instead faced interim damages of £270 million.

Importance of thinking about and managing disputes

From a disputes perspective, the benefit of specialist dispute resolution fora is significant.  The test for the meaning of any representation is objective. It requires the judge to determine what the reasonable person in the position of the representee would understand by the words used. Subjective matters are only relevant to the representee’s knowledge and reliance on those representations. Accordingly, an understanding of the industry and of the manner in which such massive projects are “scoped“, tendered, awarded and generally done is critical. Judges/arbitrators who have technical or specialist backgrounds are better able to appreciate the nature of the disputes and the evidence led on what generally are highly complex contracts.

Managing and avoiding disputes starts when the contract is drafted. Disputes arise out of parties’ erroneous or unspoken expectations. The result manifests itself as objectives not found in the scope of work and/or subsequent feature and scope creep. This can be due to ignorance (because of a failure to carry out proper requirement analysis and scoping work) or because the vendor/supplier’s marketing side had oversold its goods (often to the chagrin of the technical team).

Our next post will discuss such governance and variation issues, in particular, having a proper system in place to ensure that changes to the contract can be carried out in an effective manner.

About Shaun Lee

International Dispute Resolution and Arbitration lawyer. Fellow of the Chartered Institute of Arbitration. Panel of Arbitrators and Panelist for Domain Name Dispute Resolution at the KLRCA.
This entry was posted in Asean, China, India, UK and tagged , , , , , , , , , . Bookmark the permalink.

4 Responses to Technology and Outsourcing Hot Spots (1): Pre-Contractual Negotiations

  1. Pingback: Technology and Outsourcing Hot Spots: Governances and Change Control Procedures | Singapore International Arbitration Blog

  2. Pingback: Technology and Outsourcing Hot Spots Series (3): Termination and Post-termination rights | Singapore International Arbitration Blog

  3. Pingback: Technology and Outsourcing Hot Spots Series (4): ADR and Dispute Resolution Clauses | Singapore International Arbitration Blog

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