IT outsourcer CSL and Taunton Deane Council in the west of England are severing their housing benefit and council tax contract after just 16 months.
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"The decision we have made is a rational one that puts the needs of the citizen first," said Bob McCulloch, CSL's acting general manager at its Weston-Super-Mare centre, where the Taunton Deane work is processed.
CSL has agreed to clear all backlogged benefits claims and help Taunton Deane bring its benefits service back in-house. Details of the final settlement will be presented to a council meeting on 11 April.
Jefferson Horsley, chairman of the council's policy committee, said, "This contract has been a most unhappy experience for all it has touched.
"We can see that CSL have piled resources into the Weston office in an attempt to pull the service back to an acceptable standard. But the situation is unacceptable to all parties concerned," Horsley said.
Councillor Libby Lisgo, for the Labour group, said, "I fear things will get worse before they get better."
The decision to terminate the contract came two weeks after CSL director Dick Turpin told Computer Weekly, the company was "falling well below the expected standards" on five of its eight benefits contracts.