Technology and Outsourcing Hot Spots Series (3): Termination and Post-termination rights

Earlier in this series, we examined issues arising out of pre-contractual negotiations as well as governance and change control mechanisms. Invariably, all contracts come to an end, whether because (a) parties have fallen out and can no longer cooperate with each other or (b) there have been material breaches of the contract; or simply because (c) the customer believes that it can get a better deal elsewhere.

Part 3 of our Technology and Outsourcing Hot Spots Series considers the important topic of termination as well as post-termination issues such as exit rights and migration assistance.

Termination and Post Termination Rights

Not every breach of a contract entitles the innocent party to terminate the contract. A party who mistakenly terminates a contract without legal justification will itself be in breach of the contract. Under English / common law, a party will only be justified in terminating a contract in the following situations.

  1. The termination clause explicitly provides for termination upon the occurrence of an event or a particular breach.
  2. Where the party in breach of the contract effectively repudiates / renounces the contract i.e. by its words or conduct, that party has evinced an intention not to perform its contractual obligations.
  3. Where the term breached is a condition (as opposed to a warranty). Under this condition-warranty approach, a condition is a term which parties intend to designate as one so important that a breach of that term will result in the innocent party being entitled to terminate the contract. This is so regardless of the effect of the breach of the condition.
  4. Finally, an innocent party is entitled to terminate the contract where the breach by the guilty party has deprived the innocent party of substantially the whole benefit which it intended to derive from the contract.

There are a range of remedies that parties may resort to when a breach of the agreement occurs. Damages will be available as of right and the innocent party might also be able to terminate the contract. This right to terminate the contract can be contractual as per the termination provisions in the relevant agreement. There may also be a common law right to terminate if the contractual breach is sufficiently serious or amounts to a repudiation of the contract by the party in breach.

However, as termination is a drastic remedy, more complex and sophisticated agreements have incorporated various remedies which stop short of termination, but which nonetheless serve to set things right and to continue the business arrangements. Such rights include management meetings/reports (see Medirest), step-in rights (see BSkyB) and fee penalties (Medirest). These cases have been discussed in our previous posts on pre-contractual negotiations and governance and change control mechanisms.

Cooperation is also an important aspect of such agreements. Where the necessary cooperation between customer and provider has broken down, the courts are disinclined to compel continued performance of the agreement. In the Vertex v Powergen case that we previously discussed, Vertex (the outsourcing provider) had sought an injunction (both interim and final) to restrain Powergen (the customer) from acting on its notice of termination or to take any steps to prevent or hinder Vertex from performing its functions under the MSA. However, because the MSA required extensive mutual cooperation and goodwill between the parties, the English High Court considered that, “this [was] a contractual relationship of a kind which is inherently inappropriate for injunctive relief or specific performance” (see paragraph [8]).

The effects of termination can be drastic. Even though the contract effectively comes to an end, there may still be obligations under the contract which survive post-termination of the contract (e.g. payment obligations). Among other issues which fall for consideration: what happens to the customer’s data and how does the customer ensure that its outsourced services do not simply disappear pending a new service provider taking over the outsourced services or the customer itself reassuming those services?

Exit Provision – Post Termination Assistance Services

Termination provisions and post termination assistance provisions are particularly important in the context of complex outsourcing or technology agreements.

Properly drafted post termination assistance services provisions ensure clear demarcation of responsibilities in ensuring the transition of the outsourced services either back to the customer or to the replacement service provider. The extent of post termination assistance services can vary extensively depending on the commercial bargain and relative strengths of the parties. For example, in a basic web based cloud hosting service, post termination assistance services could simply involve a promise not to delete any data uploaded to the provider’s servers for a set period of time post termination, as well as permission for the customer to retrieve that data in the same period (see e.g. AWS Customer Agreement).

However, in a more complex multi-service outsourcing agreement, it is imperative that parties plan ahead so that the transition is as seamless and painless as possible. The case of Astrazeneca UK Ltd v International Business Machines Corporation [2011] EWHC 306 (TCC) provides good insight into exit provisions and the importance of clear drafting to ensure that the handing over of the outsourced services proceeds expeditiously.

The dispute in Astrazeneca v IBM concerned the extent and duration of IBM’s obligations as AstraZeneca’s global  IT outsourcing provider.

The agreement between the parties was embodied in a Master Services Agreement (“MSA“) which contained some 90 clauses and 32 schedules (see paragraph [3]). It was a US$1.4 billion agreement for the provision of global IT infrastructure management services (including server and storage hosting, desktop management, network maintenance and management, and helpdesk support for AstraZeneca’s employees) (“Services“). AstraZeneca terminated the MSA 3 years early.

Essentially, the MSA provided that for the duration of the Exit Period (Termination Date until Extended Termination Date i.e. 12 months), IBM was obligated to provide the Services as well as Termination Assistance i.e. the assistance necessary to transfer responsibility for delivery, performance and management of the services, back in house to AstraZeneca or to a replacement service provider.

The issues in this case involved ambiguity in the definition of “Shared Services” (because of its reliance on an undefined term “shared infrastructure“), and the ultimate termination of the supplier’s post termination assistance obligations where such obligations were to an extent themselves dependent on the prior performance of certain obligations by the customer. The MSA also left responsibility for key obligations ambiguous and any repercussions uncertain.

The net result of the High Court’s decision was that certain issues and interpretations were decided in IBM’s favour and others in AstraZeneca’s.

Notably, this case had to be brought to court on an expedited basis for a determination as to the respective parties’ rights and obligations under the post termination arrangements because if IBM was correct in its interpretation of the MSA, then it would have no obligations after the Exit Period.

Interpretation of undefined or ambiguous terms

The English High Court interpreted the MSA according to Lord Hoffman’s approach in Investor’s Compensation Scheme Limited v West Bromwich Building Society, [1998] 1 WLR 896. The court’s task is to ascertain the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation which they were at the time of the contract but excluding their previous negotiations and declarations of subjective intent (see paragraph [96]). The High Court also acknowledged the English Supreme Court’s decision in Re Sigma Finance Corporation, [2009] UKSC 2 where the majority of the Supreme Court emphasised the need to ascertain the meaning of the (very complex) Deed by “an understanding of its overall scheme and a reading of its individual sentences and phrases which places them in the context of that overall scheme“.

This approach appears to be materially similar to the Singapore Court of Appeal’s decision in Zurich Insurance (Singapore) Pte Ltd v B-Gold Interior Design & Construction Pte Ltd, [2008] 3 SLR(R) 1029; [2008] SGCA 27. One key differences is that there does not appear to be an absolute bar to the Singapore courts receiving evidence of previous negotiations or subsequent conduct. However, the Court of Appeal acknowledged that such evidence was generally unlikely to be admissible (see paragraph [132(d)]).

Such an approach is eminently sensible in very complex arrangements and agreements as it subordinates inevitable drafting infelicities and inconsistencies into the overall commercial understanding of the parties. Nevertheless, judicial interpretation should not be a substitute for clear drafting by parties.

Issue of Shared Services

Under the MSA, where the replacement outsourcing provider was unable to take over the Shared Services (see definition below) from IBM by the end of the Extended Termination Date, AstraZeneca was entitled to ask IBM to continue to provide the Shared Services for a period of a further 12 months. Paragraph 12 of Schedule 2 provided that,

“12.1 If Terminating Services are provided by using shared infrastructure and the associated Systems and Third Party contracts are not transferable to the Successor Supplier which cannot reasonably take on provision of those Terminating Services before the Extended Termination Date (“Shared Services”) then, if so requested by AstraZeneca:

12.1.1 [IBM] shall no less than thirty (30) days prior to the Extended Termination Date provide AstraZeneca with an irrevocable and unconditional offer open to acceptance within thirty (30) days to continue to provide those Shared Services on a transitional basis for no more than twelve (12) months following the Extended Termination Date to AstraZeneca and the Successor Supplier;

12.1.2 the Shared Services shall be offered on the commercial terms on which [IBM] provides similar services to or for its customers of a similar size to AstraZeneca based on the volume and nature of the services to be provided (including terms as to charges and limitations on [IBM’s] liability); and

12.1.3 AstraZeneca or the Successor Supplier may elect at their discretion to accept [IBM’s] offer of Shared Services.”

Terminating Services was defined as “[a]ll Services for which a party has issued a formal notification of termination but which continues to be provided during an Exit Period“.

The problem was that the term “shared infrastructure” was undefined. IBM argued that there was in fact no Shared Services involved and therefore no (further) extension of time was to be granted. According to IBM, “shared infrastructure” meant IT software and hardware that was not used exclusively by AstraZeneca i.e. was shared between AstraZeneca and other clients. In this respect, parties agreed that all the servers and software in IBM’s shared data centre used to service AstraZeneca were entirely dedicated to AstraZeneca and that all the servers and software could be transfer to AstraZeneca without affecting any of IBM’s other clients. In other words, there was no “shared infrastructure“.

On its own review of the MSA (and having dismissed AstraZeneca’s reliance on the factual matrix as being inconclusive), the High Court concluded that shared infrastructure did not have the narrow meaning attributed by IBM. Hence, the entirety of IBM’s shared data centre fell within the definition of “shared infrastructure” (see paragraphs [90] to [95]).

A related issue was whether AstraZeneca could be selective in the type of Terminating Services it wanted post-termination assistance with or whether it had to accept (and pay for) all such services regardless of whether it actually required them. The High Court disagreed with the all-or-nothing approach adopted by IBM. It noted that the so-called Exit Plan envisaged the possibility of a phased transfer of Terminating Services. It held that “any other construction would mean that IBM might be providing Services which AstraZeneca did not require which would have no commercial purpose” (see paragraph [127]).

Length of (post) Termination Assistance

IBM argued that once the Extended Termination Date had passed, it had no further obligation to provide Termination Assistance. In contrast, AstraZeneca considered that the Termination Date was to be extended until all of IBM’s responsibilities had been assumed by AstraZeneca or a replacement provider. The High Court held that, subject to there being no Shared Services to provide, IBM did not have to continue to provide any Services or Termination Assistance to AstraZeneca beyond the Extended Termination Date.

Somewhat troubling for the parties, the High Court considered that Schedule 22 and 22A did not contain provisions dealing with parties’ obligations in respect of the transfer of Shared Services once the 12 months post the Extended Termination Date had passed. This was an issue to be left for further arguments if necessary (see paragraph [148]).

The MSA assumed that the 12 (or 24) month period would be sufficient to transfer the necessary Services. This has the benefit of instituting a hard time limit as opposed to an indeterminate period for the parties. However, if the estimated grace period was wrong, parties would find themselves in an uncomfortable position and would require another trip to the courts for a determination.

IT Transfer Plan

The first issue was whether AstraZeneca was under an obligation to provide an IT Transfer Plan at all. The second issue concerned the extent to which IBM’s obligations under Schedule 22A to produce an Exit Plan were conditional upon AstraZeneca producing an IT Transfer Plan.

The IT Transfer Plan was defined as “one or more plans prepared by AstraZeneca for transferring some or all Services in the event of termination“. Paragraph 7 of Schedule 22 provided that AstraZeneca “may prepare” one or more such plans. On that basis, AstraZeneca sought to argue that there was no necessity for it to provide an IT Transfer Plan in contrast to the mandatory requirement for IBM to provide an Exit Plan. But where an IT Transfer Plan was produced, the Exit Plan had to conform to it. In turn, IBM sought to argue that its provision of Termination Assistance was dependent on the existence of an IT Transfer Plan and that to read “may” as permissive would flout business common sense.

The High Court agreed with IBM and considered that it was difficult to contemplate how IBM could have performed its obligations without an IT Transfer Plan. In particular, the learned judge considered that without such a plan, IBM would not know what the scope and contents of the relevant transfer was going to be in respect of its (IBM’s) own Exit Plan. The word “may produce” should in this instance be read as a discretion on AstraZeneca’s part to produce more than one IT Transfer Plan as opposed to a discretion as to whether it should even produce an IT Transfer Plan at all (see paragraph [183]).

Fees

The final issue in the AstraZeneca case involved IBM’s obligation to provide a fixed fee for Termination Assistance and whether it was contingent on (a) IBM being provided with an IT Transfer Plan and (b) the ascertainment of the duration of the Exit Period (see paragraph [194]).

Deliberately, or otherwise, the parties had not filled in the blank in Appendix 1 to the Exit Plan at Schedule 22A where the sum of the fixed fee was to have been set out (see paragraph [196]). However, the High Court considered that “[i]t was clearly intended that IBM should complete Appendix 1 by putting in a sum for the Fixed Fee” and that it was IBM’s obligation to provide a costed Exit Plan. However, the High Court also considered that the Exit Plan would be revised to take into account an IT Transfer Plan (see paragraph [198]).

Accordingly, insofar as the fixed fee was to have been predetermined and set out in Appendix 1 prior to any termination, the fixed fee “would not have been conditional upon the provision by AstraZeneca of an IT Transfer Plan“. But if the IT Transfer Plan required amending the Exit Plan, then the fixed fee might have to be adjusted to reflect those amendments (see paragraph [199] and [201]). This also applied to the Exit Period in that the period might have to be extended depending on the IT Transfer Plan and the amendments required by it (see paragraph [200]).

Dealing with Risks

Parties should also be alive to long tail risks and black swan events. One such example would be where a vendor / supplier / service provider undergoes liquidation, has a receiver placed over its assets or there is a change of control of the company. In those circumstances, it is critical to have contingency plans for project continuity. This is especially true in a design and build technology project where the intellectual property rights and physical control of the project remain with the vendor until completion of the project.

One possible (albeit drastic) solution is to ensure that the necessary design drawings, documents and software code are placed in escrow and that those escrow documents are updated on a regular basis. The escrow agent then releases the escrow documents upon the relevant trigger events occurring e.g. insolvency/receivership/change of control. In so doing, it would allow the customer to take hold of the escrow property so as to ensure continuity in the project, see e.g. Astrata (Singapore) Pte Ltd v Portcullis Escrow Pte Ltd and another and other matters, [2011] 3 SLR 386; [2011] SGCA 20. Naturally, there are additional costs associated with such precautionary measures and parties have to weigh the costs and benefits of mitigating such risks.

Similarly, other circumstances might arise which make the agreement unworkable or even impossible to perform. In those cases, a force majeure clause will stipulate what happens to the parties’ contractual obligations in a situation of specified events or events beyond the control of either or both parties. The force majeure clause can operate to terminate the contract in its entirety or excuse performance of a party’s obligation in whole or in part for the duration of the force majeure event.

It is important to note that changes to any economic or market circumstances (including currency fluctuations) which may affect the profitability of a contract or the ease of which the obligations are to be performed do not constitute a force majeure event. We have discussed the interpretation of force majeure clauses in greater detail in a previous post.

Conclusion

Parties rarely enter into a business and contractual relationship planning for the arrangement to come to an end. Rationally, parties focus their efforts working out the scope and ambit of their respective obligations. However, the nature of technology and outsourcing contracts is that such arrangements have a finite lifespan. Furthermore, in more complex agreements, termination (whether premature or otherwise) requires planning, time and effort to untangle. Exit rights and post termination assistance services fulfil those functions but require thought and planning, just like any complex arrangement.

Our next post will discuss the importance of choosing the right dispute resolution mechanism and in particular how alternative dispute resolution methods might be more appropriate and suitable for technology and outsourcing agreements.

We will examine how best to tailor such dispute resolution clauses to the type of project being undertaken and what issues to look out for when drafting such clauses.

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.
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One Response to Technology and Outsourcing Hot Spots Series (3): Termination and Post-termination rights

  1. Pingback: WIPO Survey on Tech Arbitration | Singapore International Arbitration Blog

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