© 2010 Richard Pryor & Associates
Intended Audience – This tip sheet is for the assistance of people involved in the procurement or the supply of ICT products and services.
What are the most contentious ICT contract issues?
The most common source of problems with respect to ICT contracts is an incomplete or imprecise definition of the scope covered by the agreement. Strangely, scope often receives minimal or inadequate attention during contract negotiations.
The more common contentious issues arising during ICT contract negotiations include price, payment terms, delay and the consequences of delay, intellectual property rights and limitations of liability.
How can I reduce risks relating to scope?
As noted above, scope deficiencies create more ICT contract disputes and difficulties than any other issue. A relatively small investment of time and money should be made at the outset to ensure that both parties have the same intentions with respect to scope. It is too common for the customer to be expecting the equivalent of a Lear jet and for the supplier to be expecting to deliver the equivalent of a bicycle.
In many situations, the full extent of scope cannot be precisely defined until after the preferred supplier is selected. This could be for a range of reasons but is commonly because the exact requirements will depend on which supplier is selected or because the creation of the complete specification of requirements involves a large amount of work which no-one is prepared to undertake on a speculative basis.
In these situations, it is far better for the project to be divided into phases. The first phase should involve the investigation of requirements and the creation of a detailed written definition of scope. This phase must be completed to the satisfaction of both parties before any further phases of the work can proceed. This approach is preferable even if it means that firm pricing cannot be provided until the end of the scoping phase.
What are the most common price and payment issues?
It is critical that there be certainty of price. Fixed price is nearly always preferable to an unknown price based on set rates charged on a time and materials basis. Although a fixed price usually carries a significant loading for unknown contingencies, it is quite common for the supplier to underestimate the effort required and the allowance for contingencies. As a result, a fixed price project will often be substantially cheaper than the same project charged on a time and materials basis.
A supplier will typically be seeking to front-end payments as much as possible to avoid cash-flow problems.
A supplier will also be concerned to ensure that the payment triggers are non-contentious. Suppliers will typically try to agree specific payment dates or other objective payment triggers. They will be reluctant to agree that payments are tied to matters solely within the control of the customer.
Customers will typically seek to tie payments to the value of completed work and will also seek to defer the payment of a proportion of earned value until the end of the warranty period to maintain incentives for the supplier to promptly attend to warranty issues.
Customers will also want to make payments conditional on acceptance by the customer that the work has been satisfactorily completed. This may require satisfactory completion of user acceptance tests as a pre-requisite.
How can I manage delay risks?
Delay needs to be measured by reference to a contractually committed timeline. The contract needs to include a project plan or a mechanism for the development, approval and updating of a project plan.
It is quite common for supplier contracts to contain minimal provisions about the management and consequences of delay. A supplier will seek to minimise its responsibility for the delay it causes and will seek to be compensated for delay caused by the customer or factors beyond the control of the supplier. The supplier will seek to be entitled to an extension of time regardless of the cause of delay.
A customer will seek to make “time of the essence”. This means that a failure to meet a time commitment by the supplier will be a fundamental breach of the contract and will entitle the customer to terminate the contract. The customer may also seek to include liquidated damages for delay. The liquidated damages need to represent a genuine pre-estimate of the losses which will be suffered by the customer as a result of the delay.
The customer will also seek the inclusion of mechanisms relating to delay which will only grant an extension of time for delays caused by the customer. Typically these provisions will require the supplier to notify the customer of any actual or anticipated delay and to take measures to minimise the impact of the delay.
When and why are IP issues important?
It is quite common for intellectual property rights issues to consume a disproportionate amount of negotiating time. Whilst these issues can be critical in some projects, the debates during negotiations often prove to be irrelevant in practice.
A customer rarely needs to own the IP in material provided to it pursuant to an ICT project. If the licence permitting use of the material by the customer (and any associated entities) is broad enough, IP ownership will provide no meaningful additional benefits.
The topic of IP ownership frequently arises where the customer is funding the development of material by the supplier. It is nearly always better for the customer to seek up-front discounts in the price rather than relying on some potential rewards which may flow from the further commercialisation of the product. However, if a share in further commercialisation of the material is important, then this can be agreed without the customer needing to own the IP in the material.
Where the customer insists on ownership of specifically developed material, the supplier usually insists on the exclusion of any pre-existing IP of the customer and of any third party IP which is incorporated in the deliverables. These exclusions can effectively restrict the customer’s ability to make any use of the IP in the specially developed materials.
The customer should retain ownership of its own pre-existing IP and know-how and should retain ownership of its data.
What are the issues associated with limitation of liability provisions?
The limitation and exclusions of liability sought by a supplier typically have the following features:
- An overarching limit on all liabilities arising under the contract (apart from specified exclusions – see below) equal to a specified dollar value or linked to the contract price or a multiple of the contract price.
- The limitation usually does not apply to liability for death, personal injury, damage to tangible property, infringement of third party IP rights, breach of confidentiality obligations, breach of privacy obligations, fraud and deceit. Liability of the supplier with respect to these exclusions is unlimited.
- An exclusion of liability for loss of data, loss of profit, loss of revenue, loss of anticipated savings, consequential and indirect loss and punitive damages.
A customer will usually accept that some general limitation of liability is appropriate but the amount required will usually be a higher amount than the supplier proposes.
The customer may also require that the exclusions from the liability cap include repudiation of the agreement. Repudiation occurs when the supplier decides that it will no longer perform the contract. The supplier could decide to walk away from the project if the unrecoverable costs to complete the project will exceed the amount of its liability under a capped liability provision. This has actually happened and some customers are keen to avoid this risk by ensuring that repudiation will create an uncapped liability.
The customer should consider carefully whether it is willing to accept an exclusion of liability for loss of profit and consequential losses. In some circumstances, the main losses that a customer will experience as a result of an ICT project failure will be losses of profits.
The supplier typically argues that the customer is in the best position to insure against business interruption and loss of profits.
Am I obliged to act in good faith?
It is generally accepted that in entering into and performing a contract, each party must act in good faith.
This obligation applies in addition to contract provisions and statutory obligations (e.g. the Trade Practices Act prohibition on misleading and deceptive conduct) but it is difficult to define exactly what is required to meet this standard.
Good faith could be defined as “faithfulness to an agreed common purpose and consistency with the justified expectation of the other party.”
The requirement is more commonly defined by identifying conduct which will not meet the standard of good faith e.g. “evasion of the spirit of the deal; lack of diligence and slacking off…abuse of a power to determine compliance; interference with, or failure to co-operate in, the other party’s performance.”
No matter how cunningly a party may have crafted its contract wording, that party will be obliged to act reasonably and honestly.
If a party fails to act in good faith, then it may be liable to the other party for the consequences of its bad faith and it may be precluded from enforcing some or all of its rights under the contract.
© 2010 Richard Pryor & Associates – The content of this tip sheet is subject to copyright and may not be translated, adapted, reproduced, broadcast or transmitted in whole or part without the express written permission of the author.
Important disclaimer – This tip sheet provides general comment. It does not constitute advice on any matter. No reader should act on the basis of any content without obtaining and considering professional advice upon their own circumstances. Richard Pryor & Associates and its officers and agents hereby disclaim any liability to any person with respect to the consequences of anything done or omitted to be done in reliance upon any of the content.
For further advice on ICT procurement and supply negotiations, contact Richard Pryor – richard@pryor.com.au