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Focus: Ruling on outsourcing important for practitioners

Focus on: Applies to subcontract agreements in the IT sector
|Written By Michael McKiernan

Technology lawyers say a recent court judgment on an information technology outsourcing project is a gold mine for practitioners who advise parties to subcontract agreements in the sector.  

In Atos v Sapient, Sapient recruited Atos, then known as Siemens Canada Limited, to perform certain services under its $50-million software contract with utility company Enbridge Gas Distribution.

 Siemens ultimately won a judgment worth $5.5 million after Ontario Superior Court Justice Laurence Pattillo found Sapient wrongfully terminated the subcontract, although the judge also concluded that both sides had breached the agreement.

Lawyers for the parties declined comment since the decision has been appealed, with a hearing expected at the Court of Appeal for Ontario this fall. But they are outliers among members of the IT bar, which has been set abuzz by the judgment.

Peter Ruby, a litigation partner at Goodmans LLP in Toronto, says that while the terms and clauses in the contract at issue feature routinely in outsourcing agreements, judicial interpretations of them are much harder to come by, thanks to the nature of the IT field.

“This is an industry that moves very fast, so parties don’t often have the patience for the commercial litigation process, which does not move quickly at all,” Ruby says. “Particularly when you’re dealing with computer software, it’s relatively rare to see these cases go all the way to trial.”

When there are disputes, he says, businesses operating in the technology sector also tend to avoid full-blown litigation for fear of burning bridges with major customers or gaining a reputation as a troublesome partner in projects. Arbitration is a popular alternative for its quicker timelines and the privacy of the proceedings, Ruby adds.   

“There are rulings when disputes end up at arbitration, but the only ones who know what happened are those of us who deal with those cases,” he says.

The roots of the dispute lie in Enbridge’s 2006 project to consolidate its many legacy software systems into a single, centralized structure to handle the management of functions including finances, billing, human resources and inventory management, among others.

Sapient, a long-time commercial partner of Enbridge’s, won a bid to carry out the replacement of the old system, but it lacked experience with the specific enterprise resource planning software the company had chosen to install. As a result, it subcontracted with Siemens to gain the benefit of its extensive previous knowledge of the product.   

The project began in 2007, but it quickly ran into difficulties. By the end of 2008, it was clear that the original go-live date of April 2009 would no longer be possible, with progress trailing behind target in all areas. Sapient finally terminated the subcontract for cause in June 2009, alleging that Siemens’ failure to complete the data conversion portion of the agreement to industry standards constituted a “material breach.”

The subcontract did not define what was meant to be a material breach, so Pattillo did the job himself, interpreting it to mean, in the context of the agreement, “a non-trivial breach that affects or may affect Sapient’s ability to perform its obligations under the Prime Contract in a material respect.”

The judge went on to reject Sapient’s claims that any of Siemens’ conduct had risen to that level, noting that Sapient’s prime contract required it to report any “material breach” to Enbridge in writing, but it had failed to do so.

At trial, Sapient attempted to rely on a provision of the subcontract that gave it discretion to terminate the subcontract for missed milestones that met particular criteria. However, Pattillo found that Sapient failed to exercise its discretion in good faith, noting that it made no mention of the milestone in the termination letter it delivered to Siemens.

Relying on internal emails at Sapient, the judge went on to find that the company engineered the manner of the subcontract’s termination to enable it to take over a portion of the work being done by Siemens. This would in turn improve its financial position under the prime contract with Enbridge, according to the judge, who found that Sapient’s actions demonstrated an absence of good faith.

“This case highlights the importance of acting very carefully, and with a measure of good faith when going through and implementing these agreements,” says Richard Corley, the leader of Goodmans’ outsourcing group. “In my mind, the judgment seems to turn substantially on the court’s determination about the lack of good faith.”

Ruby says lawyers should also take note of Pattillo’s extensive references to Sapient’s termination letter in his decision.

“It’s a key step. The judge makes it very clear that when you’re bringing a major contract like this to an end, how you do it is very important,” he says.

The judge also placed a great deal of credence in the periodic status, or “stoplight” reports that are a common feature of major IT projects.

“They are going to prove invaluable to the judge to figure out what happened when,” Ruby says. “They are looked at as a reliable contemporaneous account of the project’s progress, so people who work on them should be told to try to make sure they are as fulsome and accurate as possible, because you don’t want to have to explain later in court why the paperwork doesn’t reflect the reality.”

When it came to damages, the judge awarded Siemens just less than $6.3 million for Sapient’s wrongful termination, including $3.6 million for lost profits. That was offset by a $750,000 award to Sapient for Siemens’ own breaches of the agreement.

Sapient argued that the lost profits should have been excluded by a limitation-of-liability clause in the subcontract, which stated that each party would be “liable to the other . . . only for direct damages.” Neither party, the agreement continued, “will be liable to the other for indirect, special, consequential or punitive damages, or for loss of profits.”  

However, Pattillo found that Siemens’ claimed lost profits constituted expectation damages, which are direct damages and, therefore, not excluded by the clause.

The grouping of “loss of profits” with “indirect, special and consequential damages” suggested to Pattillo that the agreement only meant to exclude “consequential or indirect lost profits” from other work outside the subcontract forgone as a result of a breach.   

“Consequential lost profits do not include profits under the Subcontract but rather are indirect losses which are only recoverable when they are foreseeable or communicated to the defendant,” Pattillo concluded.

Barry Sookman, a partner at McCarthy Tétrault LLP, says the distinction between direct and indirect damages is often found in contracts governed by U.S. law.

“What a lot of Ontario and Canadian lawyers don’t realize is that terms related to damages used in the Canadian context are interpreted differently from the same terms in the U.S.,” he says. “This is a good reminder to Canadianize your loss of profit exclusions. If a U.S. vendor uses its U.S.-vetted limitation of liability, it may not actually have the consequences they intended here.”

Farrah Rahman, a lawyer with Toronto firm Cobalt Lawyers, says limitation of liability clauses are among the most fiercely negotiated in technology services agreements.

“Lawyers need to make sure they draft tighter to ensure that everything they intended is caught by the clause,” she says.


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