Failed Deals: CSC Sues Sears over Termination

Posted October 9, 2009 by   · Print This Post Print This Post

Sears and Computer Sciences Corporation entered into a $1.6 billion IT infrastructure outsourcing in June 2004.  By April 2005, Sears had given notice of termination for cause.  Claiming the termination was in bad faith as a means of escaping a termination fee, CSC sued Sears alleging irreparable injury to reputation and seeking to enjoin the termination.  The dispute took the case out of an arbitration clause and into the courtroom in proceedings seeking an injunction.  What happened?  What lessons can we learn?

Background.

The following report of the facts is based on allegations in court documents and SEC disclosures.  The author has no access to sealed records or the actual agreement or correspondence between the parties.

Sears hired CSC in 2004 for a $1.6 billion outsourcing to manage IT infrastructure for Sears’ operations.  The scope of services included managing desktops, servers, systems to support Sears-related websites, voice and data networks and decision support technology, for Sears and its subsidiaries. K-Mart, with a fresh start after completing its reorganization in bankruptcy, then entered into an agreement to acquire or merge with Sears.  The merger was to take effect on about March 3, 2005, but occurred on March 24, 2005.

The Termination Fee.

The termination provisions in the Sears-CSC outsourcing contract required Sears to pay a termination fee upon any termination for Sears’ convenience. If Sears were to terminate for cause, Sears would not pay the termination fee.

The amount of the termination fee was not fixed for the entire contract term.  Rather, it would increase from the date of contact signature as CSC invested in software, hardware, subcontracts, training, process development and other implementation during transition.  After completion of transition, the termination fee would decline over the remaining term of the contract.

The Dispute.

Before March 3, 2004, Sears probably anticipated that its merger with K-Mart might be delayed for legal or regulatory reasons.  The Sears-CSC termination fee was increasing over time as CSC continued to invest in the transitional implementation phase of the statement of work.  Evidently, the termination fee would be greater after February 28, 2005 than before that date.  Thus, Sears was motivated to terminate the agreement early, but would still pay a large termination fee if the termination were determined to have been for Sears’ convenience and not for cause.

Sears apparently approached CSC to negotiate a ceiling on the termination fee.  CSC refused to negotiate.

Sears then terminated for cause.  Sears alleged that CSC had breached because it had failed timely to meet implementation milestones and had been forced to bring in the Red Team (crisis management) to rectify CSC’s alleged breach.

CSC sued Sears for an injunction to terminate the notice of termination for cause and to enjoin Sears from invoking the post-termination provisions of the outsourcing agreement unless the termination were characterized as done for Sears’ convenience.

Legal Issues.

Confidentiality of Court Records.
At CSC’s request, the lower court sealed the pleadings, affidavits and supporting documents such as the outsourcing contract and correspondence between the parties as to the fulfillment of contract obligations.  The appellate court rejected CSC’s request to seal all appellate records and findings, thus opening the record for some public perusal.

Disclosure of the Dispute.
Sears filed a disclosure with the Securities and Exchange Commission that identified the termination of a material contract.  This disclosure, mandated by the SEC under a rulemaking effective August 23, 2004, simply alluded to a dispute over whether the termination was for cause or for convenience.  Sears informed its investors that the difference involved tens of millions of dollars. CSC also filed its own SEC disclosure.

Injunctive Relief: Was this Just a Dispute over Money Damages?
Sears claimed that CSC had no right to seek judicial relief because an arbitration clause mandated that all disputes be arbitrated.  CSC sought judicial relief because the arbitration clause probably allowed an exceptional right for either party to seek equitable relief from a court.

Equitable relief is a concept developed centuries ago under common law principles, which require that the injured party must prove that it is suffering or will suffer irreparable injury as a consequence of the threatened or ongoing actions of the respondent.  Equitable relief is not granted if the dispute is merely an argument over the non-payment of money.

Consequently, Sears responded that the dispute was only a matter of money, not one involving irreparable injury.  CSC claimed irreparable injury due to the existence of Sears’ allegedly “pretextual” claim, made in bad faith and concocted to evade a termination fee, for termination for cause.

The lower court and the appellate court both agreed with Sears and rejected CSC’s request for equitable relief, sending the case to arbitration.

Lessons Learned: New Best Practices.

This dispute highlights a number of issues under contractual clauses governing relationship management, dispute resolution and termination.   Aside from the contractual provisions, the dispute shows from evolving concerns for the enterprise customer and the service provider under common law principles of equitable relief, the Sarbanes-Oxley Act of 2002 and implementing SEC regulations.  The dispute suggests some new clauses and planning tools should be included in the normal outsourcing contract as new “best practices.”.

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