A recent judgment from the English Technology and Construction Court highlights some of the recurring themes in troubled IT contracts.

The case arose from a failed £3 million project for development of software to support De Beers’ diamond supply chain management system. It deals with three critical issues: the scope of service requirements, contract management, and the implications of the parties’ behaviour when the relationship breaks down.

Following some ‘Initiation and Analysis’ work conducted under a letter of intent, Atos signed a fixed price contract in November 2007 for delivery of a system the following June. The parties agreed to use an iterative or ‘agile’ method, meaning the requirements were not fixed at the outset and work would be produced in cycles requiring close interaction to share information and ideas and to test each stage of development.

Unfortunately the project quickly fell behind schedule. Only a matter of weeks after contract signature the parties agreed to switch the development process to a more traditional ‘waterfall’ method. This gave Atos until February 2008 to capture detailed requirements following which it would start development work and then deliver the software in one ‘big bang’ at the end of June.

Despite the change of approach the project continued to flounder and by mid-February it had become apparent the requirements were much more detailed than Atos had envisaged. This was generating a great deal of extra development work and was also starting to impact the design of the technical architecture.

At this point Atos tried to persuade De Beers that delivery should be delayed still further. After more negotiation De Beers agreed to split delivery into two phases, the first due in August and the second in October.

Evidence presented at trial to account for the delays was muddled, with each party blaming the other. On the evidence before him the judge cited four likely causes, all of which will be depressingly familiar to IT professionals: 

1. 1.Atos did not have enough business analysts working on the requirements gathering exercise, and to a lesser extent the same may have been true on De Beers’ side.
   

2. 2.There was a lack of availability of key personnel within De Beers. In particular, there were problems with staff attending workshops and generally being available to provide information. This was probably the result of a lack of direction from De Beers’ senior management, combined with Atos’s business analysts giving insufficient notice of meetings.
   

3. 3.It took much longer than expected to establish De Beers’ requirements because Atos had not fully appreciated during the Initiation and Analysis phase the complexity of De Beers’ processes.
   

4. 4.It appears that in certain areas De Beers had not made up its mind what it wanted.
   

Matters came to a head when in May De Beers refused to pay Atos’s invoice for Key Milestone 4, citing dissatisfaction with project delays and the quality of work delivered. The relationship then deteriorated rapidly culminating in Atos threatening to suspend all work unless agreement could be reached to take account of further scope creep and delays. It demanded another six months to complete the work together with payment of its invoice and that all future work be charged on a time and materials basis. When De Beers refused, Atos’s project staff handed in their security passes and suspended work. De Beers took this to be repudiation of the contract, accepted it and terminated the agreement in June.

Both parties claimed the other had repudiated the contract, i.e. that by their actions and stated intentions they’d breached the contract by indicating they didn’t want to be bound by it. Repudiation entitles the innocent party to treat the contract as discharged and to sue for damages.  

For our purposes, the case considered three important questions:

1. 1.Did the withholding of payment by De Beers, or the suspension of work by Atos, constitute repudiation of the contract?
   

2. 2.Was Atos entitled to be paid for what it claimed was additional work necessary to meet requirements going beyond what it had allowed for in its fixed price?
   

3. 3.If suspension of work did amount to repudiation of the contract, could De Beers recover the additional costs of a replacement system even though it had no present intention to procure one?
   

On the first point, the Court held that De Beers had no right to withhold payment and had done so simply to put pressure on its supplier. However, while this was a clear breach of contract it wasn’t a repudiatory breach because on the evidence De Beers had been prepared to have a commercial discussion with a view to making some extra-contractual payment (albeit not at the levels Atos might have hoped) in order to see the project through. De Beers had not therefore evinced a general intention not to be bound by the terms of the contract as a whole.

In contrast, whilst Atos did have a right under the contract to suspend work for failure to pay sums due, suspending all work unless De Beers agreed to enter into a new commercial agreement went far beyond this. Effectively, Atos had walked off the project and had only been prepared to resume work on its own terms. This amounted to a clear intention not to be bound by the contract and was therefore a repudiatory breach. (For the test for repudiatory breach, see Freeth v Burr (1874), as approved by the House of Lords in Federal Commerce & Navigation Co Ltd v Molena Alpha Inc (1979)).

The import of this part of the judgment is that parties must be able to justify their actions (e.g. in withholding services) by reference to contractual rights. Where there is no justification - or where (as in Atos’s case) a party overreaches the boundary of what the contract allows - there is likely to be a breach and, where conduct is serious enough, the Court may find that a party has repudiated the contract altogether.

On the second point, Atos claimed that the project scope had expanded in both ‘breadth’ (through the addition of new functionality) and ‘depth’ (through increased scale and complexity), and that both went beyond the parameters of its fixed price. (De Beers did in fact accept that changes in breadth - additional functionality - should be chargeable.)

The Court held that although the contract referred to specific requirements captured in November 2007 it was clear that these were very high level and not fixed – both parties were aware they would probably change as part of the iterative development process. Accordingly, if a business process fell within an ‘activity’ described in the original contract specification, a change in ‘depth’ - increased scale and complexity - was within scope and therefore did fall within the ambit of Atos’s fixed price.

In reaching its conclusion the Court was clearly influenced by the fact that Atos’s Initiation and Analysis work had given it the opportunity to satisfy itself as to the project scope and to build sufficient contingency into its price. In the event, it had done neither.

The key lesson from this aspect of the case is that suppliers must mitigate commercial risk when committing to a fixed price. This is particularly important for iterative development contracts or where the baseline requirements are high level. Assumptions and dependencies are usually the most effective way to mitigate the risk of scope creep. Too often, suppliers rely solely on change control procedures. Change control is useful (and certainly the best way to capture agreed changes) but doesn’t always help where the supplier has committed to delivering functional and technical specifications which are vague from the start.

On the final point, De Beers sought to recover as damages the additional costs of procuring a replacement system from another supplier. The judge held that because no useable software had been delivered De Beers was entitled to recover the cost of purchasing services elsewhere “whether or not [it] ha[d] an actual intention of doing so or ha[d] made up its mind whether or not to do so.”

This must be right, otherwise the Court would have failed to put De Beers in the position it would have been in had the contract been performed, which is the function of damages. However, in order to reflect De Beers’ loss of bargain the Court deducted costs it would have incurred (but had not) had Atos completed the work. As well as the balance of the purchase price this included two agreed change requests and other sums that might have been agreed had the project been completed. This left De Beers with an award of only £1.4 million – some way short of its claim of £4 million (which presumably represented the likely amount had it simply obtained a comparative quotation).