Although litigation is the ultimate weapon for organisations in dispute with a supplier, arbitration is a less costly alternative for those that want to protect their reputation and intellectual property from public scrutiny, writes Sally Whittle.
No matter how much work you put into your IT supplier relationships, you cannot guarantee against disputes, says John Jussup, vice-president and general counsel for software supplier Cognos. That is why Cognos inserts an alternative dispute resolution (ADR) clause into every standard contract it signs. An ADR clause forbids either party from filing a complaint before they have attempted to resolve their dispute before an arbitrator, who hears both sides before making a binding ruling.
While litigation is the ultimate weapon when you are faced with software that does not work, arbitration might just save your company a lot of time, money and embarrassment. "For a big company, being dragged through the court is always bad news - especially if you lose," says Gregory Hunt, manager of dispute resolution services at the Chartered Institute of Arbitrators. "Arbitration gives companies an alternative way to deal with disagreements." Today, arbitrators are not regulated in the UK so, in theory, anyone can call themselves an arbitrator. However, the Chartered Institute of Arbitrators is the UK's largest professional training and examination body for arbitrators.
So, how does arbitration work? If your company is embroiled in a conflict, arbitration allows you to present your case in private to an independent third party (the arbitrator). The arbitrator will arrange a preliminary hearing where both parties are informed which documents and witnesses will be required. This hearing also allows the companies to agree on any timings and limits on costs or legal representation. Following the hearing, both parties submit pleadings outlining their case, and the arbitrator will read these before perhaps requesting further information or statements.
Once all the information has been presented, the arbitrator will produce a statement of finding - the equivalent of a judgement in litigation. The finding will include a summary of all the points of the dispute, a ruling, and reasons explaining the ruling. In most cases, the ruling will include a financial award one party must make to the other.
This process has several advantages over litigation. Because the arbitration process is conducted in private, it allows companies to protect their reputation and intellectual property from public scrutiny. In addition, companies taking part in litigation may agree to limit the cost of proceedings or the level of legal representation. The Chartered Institute of Arbitrators charges companies £250 plus VAT to recruit an arbitrator from its ranks. From there, expect to pay anywhere from £1,000 to £4,000 a day for the arbitrator's time. The more expertise your arbitrator has, the more expensive they are likely to be. However, greater expertise may spell a quicker resolution, so beware of making false economies.
An experienced arbitrator is of particular value to companies in the IT industry, where jargon and rapid change go hand in hand. In a conventional court case, companies risk being faced with a judge who has not yet got to grips with using e-mail. In other words, if your case hinges on whether or not the XML schema provided met your own technical specification, that could spell trouble.
Arbitration enables companies to present their case to a peer who understands the terminology and concepts involved. The Chartered Institute of Arbitrators has members including professors of IT, former IT directors and chief information officers, in addition to barristers and solicitors with backgrounds in the technology sector. Michael Gifkins (see box), for example, has more than 20 years experience in the IT sector, working with companies including Intel and Logica. Gifkins has arbitrated disputes such as provision of software by a Danish company for telephone directory services in Malaysia, and the performance of corporate accounting software sold to a FTSE 100 transnational company.
Simply by avoiding litigation, you might even be able to salvage an ongoing business relationship. "You tend to walk out of arbitration with far less damaged relations because you have both had the chance to air your difficulties," says Olof Sîderblom, chief executive of arbitration company Compass Management Consulting. "Court action is risky, costly and takes up a lot of management time. Arbitration involves all of these problems, but to a far lesser extent."
Many of these benefits are most likely to be realised if companies plan for the possibility of arbitration from the outset. Like Cognos, companies should include an arbitration or ADR clause in contracts with their IT suppliers as a matter of routine. "Have a dispute section in the contract from the start which specifies that you will go to arbitration rather than litigation," says Hunt. However, companies should also insert a clause stating that they reserve the right to initiate arbitration unilaterally in the event that the supplier refuses to participate. Lawyers also advise companies to consider a clause reserving the right to take legal action where arbitration is not suitable or has failed.
This is because arbitration is not for everyone. Legally, there are some limits to what can be achieved through the process, which companies should be aware of from the start. Arbitration does not provide many of the legal protections of going to court, such as comprehensive discovery and the right to automatic appeal. If it goes poorly for you, you are stuck. The standard for overturning an arbitrator's ruling is so high, it almost never happens. "It is much harder to appeal against an arbitration finding than a court judgement, because you can only appeal on a point of law, not a point of fact," says Hunt. Even if new evidence comes to light, or you believe the judge has misinterpreted the evidence, it is just tough luck.
Moreover, although the findings of arbitration hearings are legally binding, the process cannot be used to grant an injunction and it is not based on case law, says Mark Rhys Jones, a partner at law firm Eversheds. This means that a judgement made in court can be applied to a similar dispute further down the line - but a finding in one arbitration case cannot be applied to another dispute in the future. "If you have a dispute with a customer over how you pay them, and you are likely to come up against the problem again, it is often better to go to court," says Rhys Jones. "It means that next time you have a dispute you can point to the previous judgement as evidence of how the law stands."
The best arbitration in the world can still take up to six months of wrangling and there is no rule that says you are guaranteed a happy outcome. Sîderblom says arbitrators often employ a "split-the-baby" approach, which can favour the side that comes in with the most outrageous argument. "They tend to decide in the middle, and someone with a bogus claim still tends to get something for it," says Sîderblom.
Compass Management Consulting specialises in counselling companies through the early stages of contract negotiation, and Sîderblom believes that extra time taken at this stage should remove many of the most common flashpoints from a customer/supplier relationship. "The single most common source of conflict is when the customer and supplier have different expectations," he says. "This type of disagreement comes from poor negotiation and communication at the start of the contract."
Rhys Jones frequently finds that the specification of a project means different things to different people, or a specification "creeps" over the life of a contract. While the supplier is on site, it is not uncommon for developers to ask for dozens of small changes or modifications, which will all be added to the final bill - something that comes as a surprise in too many cases, he says.
"Contracts should always include a baseline change request procedure, where all changes and costs are signed off - but people tend to get a year into the contract and forget to follow that procedure," he says.
Another increasingly common dispute is overdue projects, says Rhys Jones. The trend towards longer, bigger contracts with global IT service companies can lead to "project creep" and these cases are notoriously difficult to resolve. "Often, the user was too ambitious, or the supplier didn't get enough support, and the needs of the business changed over time - there are almost always faults on both sides," he says.
If companies want to come through arbitration unscathed, they must approach the process with an open mind. Sîderblom cites the case of a client that forced an IT supplier to meet cost promises made five years earlier - which made it impossible to then meet the service level agreements included in the contract. "There is no point going into the process if you think you are completely right and you are going to win every point," says Sîderblom. "You may have to concede some ground to get what you want."
Case study: two companies, one legal firm and an arbitration hearing
Customer X is a timber company based in southern England. In 2001, it bought some software from Supplier A to manage its stock, ordering, delivery and billing functions. After several meetings between the two companies, the finance team at Customer X agreed to pay £1m for a software package from Supplier A, an enterprise application supplier. The deal was for an extremely basic package, with most of the advanced functionality turned off. Supplier A agreed to deliver the software in 10 months.
During the course of the installation, IT managers at Customer X requested a number of modifications to customise the software. Assuming the IT managers had the authority to request changes, Supplier A complied. This lengthened the project, and after 10 months the software was incomplete. As such, the system was unreliable and not fully integrated.
Discussions broke down and Customer X threatened to sue for breach of contract because the software did not work. The supplier, meanwhile, threatened to sue for recovery of costs because the customer had only paid £500,000 of a £1.5m bill.
Law firm Eversheds advised its client, Supplier A, to consider arbitration. After a preliminary hearing, it became apparent that Customer X did not properly brief the supplier, while the supplier did not follow the correct change procedure. The arbitrator found that the customer should pay 50% of the remaining costs, on condition that Supplier A was retained to complete the roll-out and for a further, future contract.
How to become an arbitrator
- The UK's largest professional training and examination body for arbitrators is the Chartered Institute of Arbitrators
- Litigation lawyers can apply to become an associate member of the institute. Non-legal specialists need to pass the part I examinations, which are equivalent to A-level law
- To become a member of the institute you need to be a practising arbitrator or mediator or, if you have a law degree, pass a membership course. Other professionals need to pass the part II exam, which is equivalent to university entry level
- To become a fellow of the institute you will be an experienced arbitrator with a legal qualification or a lawyer with at least 10 years experience in dispute resolution. Non-legal professionals need to pass the equivalent of a law degree www.arbitrators.org
Arbitration: job opportunities for IT directors
There are job opportunities for senior IT professionals in the field of arbitration, according to Gregory Hunt, manager of dispute resolution at the Chartered Institute of Arbitrators. " We are keen to attract people from IT because we are seeing an increasing number of IT-related disputes coming through arbitration," he says. " Someone with an IT background who has also had arbitration training will be better placed to understand the jargon and unique problems particular to the IT industry."
After more than 20 years working in the technology sector, Michael Gifkins was ready for a new challenge. His career has now spanned nearly three decades and has included spells on operating system development at Intel and consulting at Logica. Combining this experience with part-time study of the law and practice of arbitration allowed Gifkins to become a chartered arbitrator and fellow of the Chartered Institute of Arbitrators.
In a commercial arbitration, the arbitrator hears evidence and legal argument. He or she then has to write an award, much like a judgement in a court of law. The role can be challenging. Cases arise unpredictably, so Gifkins combines his arbitration with work as an IT consultant and as an expert witness in IT court cases. Over the past decade, he has worked on a number of high-profile disputes where the sums at stake have been tens of millions of pounds.
The most common problem in the IT industry is its youth, Gifkins says. "We are relatively immature as a profession, so we have not developed a lot of experience of the legal aspects yet. The increasing number of legal disputes between companies and their IT suppliers is evidence of this," he says. "People so often think they know what they have bought, but there are often fundamental differences between the views of the customer and the supplier."
Gifkins advises companies to pay careful attention to their contracts, including an arbitration clause as standard. In addition, managers should pay just as much attention to the ongoing communication with suppliers. "It is easy for relationships to slide, regardless of your contract," he says.