Contract Law Analysis: Before You Sign Off

Ending or descoping a contract, particularly for IT systems or services, is something that is very much in the news at the moment. This is, therefore, a good time to highlight two key components needed for a successful approach to dealing with projects that have to be descoped or brought to an end:

• It is of particular importance to ensure that careful and legally sound plans of the moves to descope or terminate relevant contracts are made.

This won’t surprise you coming from a law firm, but if you read the section headed “getting it wrong”, below, you will understand why so many contract terminations are handled in such a way that even where there is a supplier in a serious contractual default, the customer can lose out badly; and

• Equally important and the first step, before taking any action (even before holding internal meetings or exchanging internal e-mails, which are potentially disclosable in Court if there should ever be a legal dispute), is the assessment of legal and commercial risk alongside a cost benefit analysis of the various alternative courses of action available.

Risk and cost benefits analysis
Why is this the first step? Descoping or terminating a contract, or contracts, will have costs, but there may also be savings and opportunities, such as re-deployment of internal staff to other work that may now be more productive.

To be able to assess the costs of descoping or terminating, however, will require an analysis of the contractual rights of the customer, as well as the possibility of any claims against the supplier if there has been a breach of contract.

If the cost benefit analysis around termination of the contract is not attractive, then it will be necessary to consider negotiating a solution, which may involve proposals to descope or alter the contract(s). Understanding the extent of the customer’s legal and contractual rights is therefore essential in order to obtain a clear assessment of the viable options to achieve the optimum outcome for the business.

Getting it wrong
All too often the business decision to bring a project to an end pre-dates the notice to the supplier or suppliers involved. This presents a serious legal error, as it is likely to mean that the business carries the full cost of compensating suppliers for early termination, even if the decision to stop the project is due to a contractual default by the supplier. How can that be? Let us look at a common way of mishandling the termination of a contract if there has been a breach of contract by the supplier.

Most contracts contain a termination provision in which it is normal for the supplier to have a period of notice if they are in breach of their obligations, and the contract can only terminate after that period has expired, unless the breach is so serious that it is incapable of remedy.

The pitfall for the customer comes in the words typically found in these clauses, “unless remedied by the Supplier”. The reason is, that if the supplier is denied the opportunity to remedy, because the customer has in fact already decided to cancel the project internally, then the supplier can argue that the notice cannot genuinely give them the opportunity to remedy their breach during the notice period.

Intellectual property
Unfortunately, there are other ways in which it is possible to get it wrong. One of these is failing to recognise the impact of termination on the intellectual property rights in materials involved in the contract.

This can take a number of forms:

• Automatic termination of software licences;

• Reversion of ownership in copyright, so that the supplier ends up owning the intellectual property;

Consider the situation where the supplier has been commissioned to produce a detailed specification, or even a set of modules. Some way into the project, possibly near its completion, there is a problem and the customer acts in such a way that the supplier is entitled to treat the contract as having been terminated. What then is the position over ownership of the specification, or the modules that have been developed?

Under the Copyright, Patents and Designs Act 1988, in the UK, the law is that, absent to any writing to the contrary signed by the supplier, any copyright in work created by the supplier or its employees will belong to the supplier, and not to the customer.

Failure to appreciate the consequences of termination on intellectual property rights can put the customer in a position where it has to go back to the supplier to plead for rights that could have been preserved, without necessarily losing the customer’s right to go elsewhere to have the work completed by a third party.

Conclusion and watchpoints
If descoping or terminating is not going to end up costing more than it was designed to save, at least the key points below should be followed:

• Use the procedures provided in the contract and overall good practice in contract management – for example, change control procedures must be adhered to. If they are not followed it will be much more difficult later to argue the problems that have arisen were not “accepted” by the customer, also it will be complex and expensive to prove what the agreed changes to specification and timetable were.

• Understand the escalation procedure. Either the procedure laid down in the contract (e.g. meeting between project managers first, then if not resolved within three days, a meeting of directors responsible and so on), or the procedure that the termination and remedy for breach provisions, as well as contract law generally prescribe;

• Take advice on how to protect internal communications from the risk of becoming evidence if any legal claim develops. Be prepared for the worst and it may not happen!

• John Mawhood is a partner in the commercial technology department at Tarlo Lyons Solicitors.