Information Technology (IT) Contracts: 3 Key Lessons for Customers & Service Providers
Published:
March 30, 2017
Author(s):
There are very few examples of a Canadian court interpreting and opining on the provisions of an information technology contract. So the Ontario Superior Court of Justice’s recent decision in Atos v. Sapient, addressing a dispute concerning an information technology outsourcing project, provides interesting insight into the issues that both customers and service providers should consider when negotiating, drafting and performing IT contracts specifically, and commercial contracts generally. Here are three key lessons we can learn from the Court’s decision.
1. What we learned about a “Material Breach”
As is typical, the contract in Atos gave the customer the right to terminate the contract upon the occurrence of a “material breach”. The contract didn’t define the term “material”, so the Court examined other provisions of the contract along with the parties’ behaviour after the alleged “material breach” to interpret what “material” meant. Another provision of the contract required the customer to make certain notifications to a third party if any breach of the contract would “affect [its] ability to perform its obligations [to such third party] in a material respect.” Therefore, the Court decided that “material breach” meant “a non-trivial breach that affects or may affect [the customer’s] ability to perform its obligations [to third parties] in a material respect.” The Court further noted that the customer had never treated the service provider as if it were in material breach of the contract.
The lesson: clearly and precisely define what constitutes a “material breach” in commercial contracts. In the absence of such a definition, courts will look to other provisions of the contract, including those that deal with how the parties are to behave vis-a-vis third parties after a “material breach” has occurred, and the parties’ actual behaviour after the alleged “material breach” for guidance in determining whether the conduct met the intended “materiality” threshold.
2. What we learned about “good faith” terminations
The Court rejected the customer’s claim that the service provider’s failure to meet a specific milestone entitled the customer to exercise its discretionary right to terminate. The Court cited the customer’s failure to reference this ground for termination in its termination letter to the service provider. The Court also decided that the discretionary nature of the customer’s right to terminate (upon the failure to meet this particular milestone) meant the customer must exercise it in good faith, and concluded the customer didn’t: the customer invoked the service providers’ non-performance of the milestone after the termination; it failed to invoke the informal dispute resolution process under the contract; and evidence (emails among the customer’s executives produced at trial) disclosed the customer’s motives in terminating the contract centred on improving its own financial position rather than responding to the service provider’s alleged breach.
The lesson: ensure contracts contain clear and specific instructions on the type of information that must be included in a notice/letter from one party to the other to validly terminate the contract. If any contractual right of a party is discretionary (for example, uses permissive rather than mandatory language, like “may” rather than “shall”), parties must exercise such contractual rights in “good faith”. And it’s not all about what’s actually written in the contract; how the parties behave is relevant to determining whether they acted in “good faith”. The court will examine the parties’ behaviour – including their non-privileged email communications – before and after the termination to determine if they acted in “good faith” (though contracting parties are free to act in their own self interest and pursue whatever advantages may flow to them from the contract – as long as they do not lie or mislead the other party in doing so).
3. What we learned about “limitation of liability” provisions
Under current legal principles, a breach of contract allows an innocent party to collect the payments it would have otherwise received under the contract (less the costs they would have incurred carrying out their obligations under it). In Atos, the service provider sued the customer for “lost profits” as a result of the customer’s wrongful termination of their contract. In its defence, the customer pointed to a clause of the contract specifically excluding “lost profits” as a prong of liability, a standard term in most IT outsourcing contracts: “…neither [party] will be liable to the other to the other for indirect, special, consequential or punitive damages or for loss of profits”. The Court decided that excluding liability for “loss of profits” would mean effectively excluding the default remedy for a breach of contract under current legal principles, so it interpreted this provision as excluding liability only for “indirect”, and not “direct”, damages. Consequently, the reference to “loss of profits” in the provision limited the customer’s liability to “indirect” or “consequential” loss of profits, but didn’t protect it from liability for “direct” forms of damage – like the service provider’s lost profits as a result of the customer’s breach.
The lesson: regardless of what limitation a contract’s terms place on each party’s liability, their ability to “contract out” of fundamental legal remedies for breach of contract might not be enforceable. So including in a typical contract clause excluding the breaching party’s liability for the innocent party’s loss of profits might not protect it from liability for the innocent party’s direct financial consequences.
Please contact your McInnes Cooper lawyer or any member of the Technology Team @ McInnes Cooper to discuss the negotation, drafting or interpretation of information technology contracts.
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