Terminating IT and outsourcing contracts: designing and implementing a successful legal strategy

Articles Written by Michael Bywell

For most organisations, termination issues arise on a routine basis due to changes affecting the business - for example, as a result of recent acquisitions or expansion. Where this occurs there is often no need for inherited IT systems or outsourcing arrangements so steps are taken to terminate the third party supply contracts involved. 

The need to terminate can also arise where trading conditions change and it is thought necessary to change the way in which the business services its IT requirements and business processes - for example, to achieve deeper cost savings. Depending on the view taken, this may involve outsourcing existing internal requirements or in-sourcing services currently performed by a third party supplier (i.e. taking the work back in-house). There might also be a debate over whether to "off-shore" services or bring them back "on-shore."

A third category arises where the business wishes to terminate due to the poor performance of third party service providers. In this case, the business may wish to replace the supplier with another company or perform the work itself.    

In many respects, the task of identifying the need for change is considerably easier than the job of implementing it. In most cases the need for change will speak for itself. However, setting up and implementing the termination event requires careful consideration and it is prudent to obtain legal advice from the outset in order to inform the strategy to be adopted and ensure that the correct notice procedure is followed. It may also help in protecting any sensitive internal communications from disclosure in the event of subsequent litigation. 

Termination is clearly a major event in the life of any commercial contract. For the party on the receiving end of a termination notice it will probably result in a great deal of disappointment, a lost business opportunity and, in some cases, reputational damage. 

Consequently, that party is likely to fight any attempt to terminate (other than in the most straight-forward of cases such as expiration or non-renewal and termination for convenience) and look to secure some form of compensation. This means that the party seeking to terminate must get it right from the outset and prepare itself for a tough set of negotiations in relation to a consensual exit or, failing that, litigation.

What follows is a selection of legal tips for preparing and executing a successful termination strategy:

  1. Fully investigate the contract and its termination provisions in order to understand the legal remedies available and the risks involved. Be realistic and work on the basis that if the matter goes to court there is every chance that different courts and judges will take different views on whether a particular set of facts justifies termination. Assessing the merits of whether a particular set of circumstances justifies termination for breach is seldom straight-forward.
  2. Formulate a strategy for termination including how to generate leverage. In some cases businesses might rely on alleged poor performance by the suppler in order to generate leverage during exit discussions - even though the supplier's performance may not, of itself, be serious enough to justify termination for breach. 
  3. On the other side of the fence, suppliers should be alive to this tactic and ensure they undertake a merits assessment in order to evaluate the customer's allegations of poor performance and formulate their own negotiating position.
  4. It should be remembered that a mere breach (as opposed to a serious breach justifying termination) will not entitle the customer to end the relationship. The customer may, however, be entitled to claim damages.
  5. Where delay is involved, bear in mind that the courts will generally expect the defaulting party (in this case, the supplier) to be afforded a reasonable period in which to cure any breaches and avoid termination. The fact that the date for performance has passed will not automatically mean that the breach complained of is "incapable of remedy". 
  6. The exception is where the time obligation is an "essential" term that requires strict compliance. In that case summary termination will be permitted.
  7. If and when the right to terminate does arise, a decision on whether to terminate should be taken without delay. The courts will generally allow some latitude but will not allow the terminating party to dwell on matters for an unreasonably long period of time. In some cases, the right to terminate may be lost.
  8. In modern IT and outsourcing contracts, it is common for customers to agree to perform certain obligations such as supplying information about the business, granting access to locations, procuring the performance of third parties, co-operating in relation to transition and so forth. Where the customer breaches these sorts of obligations a supplier facing termination might argue that it would be wrong for the customer to be allowed to terminate where it is also in breach of contract.  The answer here is that the courts will generally endorse the customer's purported termination so long as any breach by the customer is not so serious as to justify termination by the supplier. In other words, the mere fact that the customer may have breached the contract will not prevent termination.  
  9. Consider and follow the notice provisions in the contract. A failure to follow notice provisions may invalidate the termination. For their part, suppliers should keep in mind that, in assessing whether notice has been given, the courts take a pragmatic view and will look at whether a reasonable person in the position of the recipient of the notice is "left in no doubt" that the right to terminate has been exercised.
  10. Work out which clauses survive termination. If the contract contains an ADR provision there may be an argument that it survives termination and must therefore be followed for resolving disputes including whether or not termination has been validly exercised. Exclusion clauses should also survive termination.

All contracts come to an end at some point. Some will simply expire or be terminated for convenience. Others will end in more acrimonious circumstances and may end up in court unless a consensual termination can be agreed. 

Where contracts are terminated without proper justification, the outcome may be to reduce (or eliminate) any anticipated savings associated with the decision to change contractual arrangements. Proper consideration should therefore be given to the contract between the parties and the risks associated with getting it wrong - before any steps are taken to end the relationship. 

In most cases, the desired outcome for all parties will be a negotiated or consensual termination. Neither party will want to become embroiled in a time-consuming and expensive legal battle. For its part, the customer will probably want a quick and clean exit and co-operation in transitioning the services back in-house or to another supplier. On the supplier side the main concern (commercial terms apart) is likely to be reputational damage and how this can be minimised or eliminated altogether. 

Hopefully the guidance provided in this article will go some way towards helping readers achieve good outcomes and avoid the legal pitfalls that can be involved when seeking to terminate IT and outsourcing contracts.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).