Do Your Contracts Need Rebooting?

April 30, 2005

Peregrine Systems Limited v Steria Limited [2005] EWCA Civ 239 involved issues which are common themes in many IT disputes. The customer (Steria) terminated the agreement it had with the supplier (Peregrine) in relation to the provision of software for Steria’s call centres. As a result of this, Peregrine sued for sums due under the contract and Steria counterclaimed, alleging misrepresentation and breaches of contract entitling it to terminate the contract and claim damages (including all sums already paid to Peregrine and for its wasted time). At the initial trial ([2004] EWHC 273), it was held that Peregrine had not committed any breach of contract, let alone one serious enough to justify termination, and that there had been no misrepresentations. In addition, the judge held that, even if there had been misrepresentations or breaches by Peregrine, Steria had lost the right to rescind or terminate the contract because it had affirmed the contract or waived the breaches.

The Issues on Appeal

Although Steria appealed on 23 grounds, ultimately (and fortunately for the length of this article) the Court of Appeal had to consider only two key issues:

1. Was there a serious breach justifying termination due to the time it took Peregrine to perform?

2. Did Steria waive its rights to rescind or terminate?

Was there a serious breach justifying termination due to the time it took Peregrine to perform?

Although there were no dates stipulated within the contract in relation to delivery, it was common ground that, whatever the contract required Peregrine to do, it was obliged to do that within a reasonable time. However, Steria mistakenly believed that it had a fixed task contract entitling it to full implementation for £200,000. Unfortunately for Steria, due to the way the contract was worded, it was held that Peregrine was obliged to provide only £200,000 worth of implementation services, not to fully implement the software for £200,000. Once the £200,000 had been exhausted, there was no continuing obligation on Peregrine to do anything further towards implementation within a reasonable time, unless a further agreement had been reached in relation to such further work (which it had not).

The Court of Appeal also pointed out that the obligation to perform within a reasonable time is different from time being of the essence. Since the contract did not stipulate that time was of the essence, if there had been a breach of the obligation to perform within a reasonable time, Steria would still have had to establish that this was a breach so serious as to deprive it of substantially the whole benefit of the contract.

Did Steria waive its rights to rescind/terminate?

The answer to this question became academic in the case, given the Court of Appeal’s decision on the first issue. However, the answer is still a salutary lesson for both suppliers and customers in IT projects. The Court found that, although internally Steria had become very impatient with Peregrine and had decided to approach the contract on the basis of “fix it or forget it”, Steria had not clearly communicated to Peregrine that it considered there had been serious breaches of contract and that it was reserving its position to terminate for these. Rather, Steria, with knowledge of the relevant facts, acted in a manner consistent only with having elected to affirm the contract. Steria continued to use the licensed software within its operations, took delivery of new software, had one of its employees trained on the software, had discussions about further training for others in due course and allowed Peregrine to carry out further work.

The Court appreciated that “it is not always easy for the customer to take the ultimate step of terminating the contract when repudiatory breaches have occurred. On the other hand, it is not possible to rely on an implied reservation of rights when evidence of what was said and what was done point unequivocally to an election to affirm the contract“. The Court of Appeal did not find it necessary to deal with the issue of alleged misrepresentations since, even if Steria had succeeded in establishing any misrepresentations, the right to rescind would have been lost because of Steria’s actions affirming the contract.

The case therefore demonstrates two key issues which routinely arise in IT contracts. First, when negotiating IT contracts, how does the customer secure a contractual commitment to timely delivery when a supplier will not agree to “time of the essence” in the contract? Second, how does the customer manage the contract when things start to go wrong so as to avoid a situation where they are held to have waived the right to terminate the contract?

Getting the Drafting Right

Achieving the agreement of a supplier to a contract for delivery on “time of the essence” terms is rare in IT contracts, as it usually requires the customer to have a strong bargaining position. Often, therefore, if the customer has not negotiated such terms but wants to terminate and walk away, it must show that the failure by the supplier constitutes a repudiatory breach. This will usually require showing that the supplier’s conduct either goes to the root of the contract, frustrates the purpose of the venture or deprives the customer of “substantially the whole benefit which it was intended [the customer] should obtain from the contract ” (see Diplock LJ in Hongkong Fir Shipping Co v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26 at p 70). To assess this, a court would have to examine the precise wording of the contract and interpret the position by having regard to all the relevant circumstances. Accordingly, any customer trying to assess the position itself may well be uncertain about whether or not it is entitled to terminate and whether a court would assess the position in the same way.

It is however wrong to assume that there is no route available other than to provide in the contract that the customer will have clear grounds to terminate if delivery is not made within a given time frame. For example, the concept of material breach can be introduced into the contract as a ground for termination and the completion of delivery by a long-stop date can be made one of the supplier’s obligations, the breach of which is explicitly a material breach. The contract should seek to ensure clarity, so far as possible, as to what specifically will constitute material breach. The parties should also give thought to clarifying the extent to which the supplier is allowed to be given the opportunity to remedy its own breach before the customer may terminate. Further, and if appropriate, the contract may make explicit which breaches are to be regarded as irremediable. Doing this will help to ensure that the customer is not obliged to take the risk that the extent of the supplier’s breach, should it arise, is insufficient (or insufficiently clear) for the customer to terminate by reason of repudiatory breach and/or that the period the customer must allow the supplier to attempt to remedy a breach is beyond what is commercially acceptable to the customer.

Avoiding Waiver of Rights

With such uncertainties existing as to whether the right to terminate exists, how does a customer (or indeed a supplier) avoid waiving any right to terminate that it does have?

A crucial point, but one that is overlooked on a surprisingly frequent basis, is to be aware of the provisions in the contract. Too often those involved with the actual implementation of an IT contract have no idea of the detail contained in it, meaning that key contractual timetables and procedures for notifying breaches or escalating disputes are overlooked.

When communicating with the supplier, a customer should be clear in its communications and conduct, and take care not to compromise its position unintentionally. In Peregrine, it was clear that, whilst Steria was becoming increasingly frustrated with Peregrine behind the scenes, Steria had not properly expressed those frustrations to Peregrine, nor had Steria specified that it considered that these were material breaches entitling it to terminate the contract. In order to avoid this, communications and conduct should be carefully considered and routed in order that the right course of action is taken and a consistent and clear message is given.

Consideration should also be given to expressly reserving the right to terminate the contract. Whilst this can sometimes appear inflammatory, if that message is communicated carefully (and, ideally, within a dispute escalation procedure) then, as well as preserving a customer’s rights, the supplier will be left in no doubt that the alternative to acting on the complaints being made will be termination of the contract.

The above messages are equally important for suppliers to bear in mind in negotiating contracts, as well as managing projects and any disputes that arise out of these.

Almost all successful IT projects will require a degree of give and take. Inevitably, it will not serve either party well to jump on every difficulty – some flexibility is essential on both sides both when negotiating the contract and in progressing the project itself. However, it can be a fine line between being co-operative and being compromised.

Bill Gilliam is a partner and Claire Frater is a solicitor in the litigation and dispute management group of Eversheds LLP. Both specialise in dealing with IT disputes.