Project Failure: Termination
Project Failure: Termination
Some projects fail despite the parties’ best efforts to save them.
A project can be brought to an end by a variety of means. The most obvious is termination. To a party weary of a project’s failings this is an option with a number of attractions. It can be quick. It emphatically signals displeasure with the other party’s shortcomings. It also raises the possibility of redress: whether in the form of a damages claim, withheld payments or simply through exerting commercial pressure by operational disruption.
Some of these steps are more dramatic than others but any termination is an inherently combative step. Above all, termination requires strategic planning rather than knee-jerk action. This is because there are always risks in terminating and the options should be considered carefully. A botched termination can have disastrous consequences: if the termination doesn’t comply with the contractual or broader legal framework, it will be unlawful and may expose the terminating party to a substantial damages claim.
The most common (and most contentious) scenarios involve termination for material or repudiatory breach.
1.Material Breach
An outsourcing contract will usually set out in detail a party’s termination rights in the event of material breach by the other. Those rights may be exercisable straightaway or only after a cure period. This is straightforward enough. Difficulties usually arise however because contracts are rarely prescriptive about what actually constitutes material breach. This is an important question because not every breach is material.
In general terms, a material breach is one that:
•if not remedied, has a serious effect on the commercial consequences of the contract;
•is not due to mishap, mistake or misunderstanding; and
•where the issues or values involved are not trivial. (So, for example, a six-week delay to delivery of a critical path milestone in an eight-month project would not be trivial. A two-day delay to a non-critical deliverable in an 18-month project would be.)
The status of a breach can only be decided definitively on a case-by-case basis. Recent judicial pointers indicate that the Court tends to attribute significance to a party’s payment obligations (Dalkia Utilities plc v Celtech International (2006)) but will attribute less importance to a party’s failure to deliver on time an obscure deliverable buried in a schedule.
2. Repudiatory Breach
This is the nuclear option. It involves the aggrieved party accepting a beach which is properly classified as repudiatory and electing to bring the contract to an end. A breach is repudiatory when it deprives the injured party of a substantial part of the benefit to which it was otherwise entitled.
What this means in practice is that a breach must in some way be fundamental: it must go to the root of the contract and bring the project to a juddering halt. So, for example, a customer’s decision to shut a project team off-site without obvious justification has been held to amount to repudiatory breach (Hayes and Anor v Peter Gallant (2008)) as has a supplier’s decision to suspend all work pending renegotiation of a contract on its own terms (De Beers v Atos (2010)).
If a breach can properly be classified as repudiatory the advantages of terminating will be readily apparent. Termination is immediate and damages can be calculated more broadly than is usually the case with a material breach (Photo Production Ltd v Securicor Transport Ltd (1980)).
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There are a number of other points to bear in mind when considering termination.
It’s vital to ensure you haven’t inadvertently affirmed or waived the breach you would otherwise rely on. This is a trap for the unwary. A customer might for example have agreed to revised milestones in order to accommodate the supplier’s failure to meet an earlier interim project deadline. If that agreement was without reservation of rights, the customer may have affirmed or waived the breach. Acting in a way which is inconsistent with an entitlement to terminate effectively prevents the aggrieved party from relying on it.
Great care should also be taken with the termination notice. The Court has traditionally required a terminating party to adhere strictly to the procedural requirements of the contract. It is now sometimes more flexible and may also consider the commercial backdrop and intent of the termination clause. That’s all well and good, but there’s no point testing the limit of the Court’s leniency. Any party serving a termination notice should make every effort to comply precisely and unequivocally with the letter of the contractual termination requirements.
Thought should also be given to what the other party might do when it receives the termination notice. Might it for example seek an injunction restraining the termination? A terminating party should anticipate this outcome and have a Plan B. Remember that service of a termination notice tends to be just the beginning of the disengagement process. Strategic anticipation of the other party’s response is crucial.
Practical thought should also be applied to the post-termination landscape. If the terminating party is a customer it should have transitional business arrangements in place, have already anticipated any reprocurement obligations and have a replacement supplier lined up.
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While disputes in outsourcing projects are not uncommon suppliers will always prefer to avoid a public and acrimonious divorce because, regardless of the financial outcome, negative publicity is bad for business. There are in any case other ways of exerting pressure: ‘nickel-and-dime’ change requests; limiting service provision to the letter of the contract; demanding compensation for alleged customer delays and errors; and, where the customer has terminated, claiming this as a pretext to avoid charges for what is really a termination for convenience.
An early exit from an outsourcing contract brings much difficulty for both parties. Customers in particular are well advised to stay focused on the bigger picture and their ultimate objective. More often that not, renegotiation is a better course, whether at an operational level or more formally in conjunction with the contractual dispute escalation procedure. Renegotiation will generally centre on a change in scope, re-pricing or some other combination of measures to get the project back on track.
Project Failure: Termination
08/06/2010
Terminating a failing contract may be superficially attractive but termination requires strategic planning rather than knee-jerk action.
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