Outsourcing: Don't push the button to wreck your deal

If you find yourself at the end of your tether with your supplier, the best course is rarely to terminate the contract. Arbitration or even litigation are more effective.

If you find yourself at the end of your tether with your supplier, the best course is rarely to terminate the contract. Arbitration or even litigation are more effective.

Familiarity breeds contempt. The constant visibility of an IT services provider will not necessarily inspire love in the heart of the customer. Relationships at operational level break down, messages of blame are exchanged, and the opposing camps retreat briefly to seek legal advice. Can they terminate the deal?

The answer is usually "no", and indeed that is probably what the answer needs to be in most cases. Termination is the nuclear option, and the premature end of a services agreement is always painful.

Equipment and people need to be moved, systems migrated, data separated (and not lost forever), employees need to be counselled, and despite all this, both businesses still need to make money. So what is the alternative?

There is a common misconception that termination is the only way to deal with a contract that has gone wrong. It isn't. In fact, if you look at a book on the law of contract (some of us have to), you probably won't find a section on termination.

Contracts are written to be performed by the parties. If a party fails to perform, then the proper remedy in law is to sue that party for damages.

The contract will still continue - legal action does not stop it - and the litigation will run alongside. This commonly happens in construction contracts, when disputes may go to arbitration or expert resolution during the building process, and there is no reason why it shouldn't happen to IT contracts as well.

Normally, the only grounds on which a contract can be terminated are those that the parties set out in the contract itself, which is why almost all services agreements contain a termination clause.

Typically, these clauses state that termination can be effected where there has been a breach of contract that has not been remedied despite written notice.

In some contracts, the customer may be able to terminate on notice for any reason, but there is often a specified financial penalty for doing so.

If there has been a breach of contract and the wronged party still wants to terminate, the question to be answered is whether the breach is serious enough to justify termination.

It is common to see a clause saying that only "material" breaches will warrant termination, and this requires the lawyers to decide whether the breach in question really is "material" or not.

They are likely to take a cautious approach. Because termination has such severe consequences, courts are likely to decide that the parties intended the word to mean "very serious" and not "very irritating".

Also, a party that wrongfully terminates an agreement will itself be guilty of breach of contract and will find itself exposed to a potentially huge claim in damages.

But even if there are proper grounds under the contract for termination, is it the right decision?

Customers who are contemplating termination need to be sure that alternative arrangements can be put in place to undertake their work, and they may find other suppliers reluctant to take over a relationship that is clearly a difficult one without demanding a steep increase in price.

Suppliers thinking about ending it all need to consider their reputation, and the unrecoverable losses that may remain once all the difficult disentanglement has taken place. They can also not expect the most sympathetic hearing from the court if the customer is put to disproportionate expense.

Litigation, without termination, may well be the cheaper option. Court proceedings are not inevitable; mediation by an independent third party has a lot to recommend it because it is flexible, confidential, fast and relatively inexpensive.

Some contracts provide for arbitration, which is not necessarily less expensive or quicker than a court case, but should be confidential.

The usual problems, in practice, are the human beings in charge. People are always reluctant to admit mistakes or lack of experience, and will blame the other guy. It is very rare indeed to find a disintegrating outsourcing agreement where there has been fault on one side only.

If disputes are to be resolved, senior managers on both sides need to make pragmatic decisions. They may have to move people to other tasks in order to take the heat out of the dispute. However, they probably don't need to push the big red button.

Quentin Archer is a partner at the law firm Lovells

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