Failed Deals: BSkyB, EDS and Enforceability of Contractual Limitations on Liability for Fraudulent Misrepresentation
February 2, 2010 by Bierce & Kenerson, P.C.
© 2010 Simmons & Simmons. Reprinted from www.elexica.com with permission.
Judgment in the long running case of BSkyB v EDS was handed down on 27 January 2010, by Ramsey J in the Technology and Construction Court. Although the case has not turned the law on misrepresentation upside down, it hammers home the severe consequences a court will impose on a business if it finds a person acting on behalf of that business has made a fraudulent misrepresentation. Although BSkyB alleged fraudulent misrepresentation in respect of several aspects of EDS’s tender process, it only succeeded in proving that EDS’s assurance that they had carried out a proper analysis of the amount of elapsed time they would need to complete the delivery of the project and “go live” was fraudulent. Barring any successful appeal, this fraudulent misrepresentation looks set to cost them around £200m.
The court battle between BSkyB and EDS is a tale of a contract process that appears to have gone wrong from the start; various allegations of lies told by employees and, bizarrely, a dog with a Masters Degree in Business Administration.
The background
The handing down of the judgment in this case marks the end of a process of deliberation that began in July 2008 when the last court hearing on the case took place. The case itself took a number of years of preliminary argument and amendment of each side’s pleadings to come to court. It concerns allegations of fraudulent misrepresentations and breaches of contract that go back a decade.
In 2000, BSkyB invited Invitations to Tender for a multimillion pound project to build a Customer Relationship Management (CRM) System, which it hoped would cut costs, improve the service offered to subscribers and even reduce the “churn rate”, ie those subscribers who would leave in frustration having failed to get their systems to work. EDS emerged as the successful bidder beating, among others, PwC with their tender.
In an all too familiar way, things started to go wrong with the contract fairly quickly and deadlines slipped. The parties decided to deal with these delays by essentially putting the project on hold and replanning how the rest of the project would proceed; a pragmatic approach. As a result, the original contract was largely superseded by a “Letter of Agreement”, which purported to exclude liability for “all known claims and unknown claims” for breaches of the original contract that EDS may have committed.
This second attempt at implementing the project was as unsuccessful as the first and the companies parted ways in early 2002. Again, in circumstances that are all too familiar, how the parties parted ways was a matter of dispute between them. BSkyB argued that they had accepted a repudiatory breach of contract by EDS and EDS fired back that it was they who had terminated the agreement for non payment of invoices by BSkyB, which they counterclaimed for at trial.
Fraudulent misrepresentation: BSkyB subject EDS to russian roulette
BSkyB alleged that a number of fraudulent misrepresentations were made by EDS both during the tender process and later into the signing of the Letter of Agreement and attempted resurrection of the project. Ultimately, Ramsey J ruled against most of the fraudulent misrepresentations alleged, including representations about EDS’s own resources and readiness to start work.
The importance in alleging fraud arose because the contract contained a limitation of liability provision which potentially restricted BSkyB’s recoverable damages for EDS’s actions. BSkyB claimed that its damages were in the region of £700m. If it could demonstrate that the breaches were fraudulent, then as a matter of law the limitation of liability provision restricting recoverable damages would not apply. In England, it is unusual for fraud to be alleged in civil proceedings. Before a lawyer commits to such a pleading in litigation, he must be satisfied to a higher standard than is ordinarily the case that evidence of fraud exists. This was a fairly high risk strategy for BSkyB and no doubt the substantial legal costs were increased by the need to investigate the background evidence even more thoroughly than usual.
BSkyB however, only had to succeed once on the fraudulent misrepresentation allegation and did so with regard to EDS’s misrepresentation that it had carried out a proper analysis of the amount of elapsed time needed to complete initial delivery and “go live” of the project. EDS had not done such an assessment, yet during both the tender process and prior to the signing of the original contract, Ramsey J held that Joe Galloway MBA, an EDS employee, had made knowingly deceitful representations that EDS had made the assessment (more on his credibility below). The judge said that but for this misrepresentation, the contract would have been awarded to another of the tenderers.
Other claims
BSkyB was also successful in a claim of negligent misrepresentation against EDS with regard to the replanning process that had gone on prior to the Letter of Agreement being signed. The judge found that EDS had not carried out a proper analysis and replanning exercise to produce an achievable programme for the implementation of the system. Contrary to the previous misrepresentations, Ramsey J held that this misrepresentation had only been made negligently.
EDS were also found liable for a number of breaches of contractual terms, including a breach of the invariably implied term that EDS would carry out its work with reasonable care and skill.
Witness credibility and Lulu the dog, MBA
One of EDS’s chief witnesses, Joe Galloway, claimed in his various witness statements that he had achieved an MBA from Concordia College, St John. He said in evidence that he attended classes at the college, while working on a project for Coca Cola on St John in the US Virgin Islands for a year in the mid 1990’s, flying to and from the island by commuter plane. He even supplied materials which he said “may have” been associated with the classes he took.
BSkyB’s lawyers exposed this account as false. Not only had Mr Galloway not attended MBA classes on St John, but the island had no airport for his commuter aeroplane to land at and no Coca Cola facilities for him to have worked at. While the MBA did superficially exist, it was an internet degree, available to anyone for whom an application was filled out and the fee paid. Mark Howard QC, Counsel for BSkyB, starkly illustrated this by obtaining an MBA from the institution for his dog, Lulu. Most gallingly for Mr Galloway, the dog was awarded better marks than he was.
EDS’s lawyers appear to have made a brave effort to salvage their witness’ haemorrhaging credibility by citing various authorities which state that just because a witness has been shown to be lying in some respect does not mean that they have been lying all the time. However Ramsey J noted the “same confident manner” being present in his false testimony concerning his time at Concordia as was in his testimony concerning the facts of the case and held his credibility to be “completely destroyed”, saying that:
“My general approach to his evidence has therefore to be that I cannot rely on the truth of his evidence unless it is supported by other evidence or there is some other reason to accept it, such as it being inherently liable to be true.” Mr Galloway was dismissed from employment during the trial by EDSC, a company related to EDS, for lying about his MBA. The employment status of the similarly qualified dog is currently unknown.
Lessons for drafters: exclusions of liability
As in every complicated commercial relationship, there were as noted above, various limitations on liability (overcome by the successful claims of fraud), entire agreement clauses and other common clauses which EDS tried to use to deflect BSkyB’s claims. These were drafted by experts in their fields and so how they stood up will be of interest to every draftsman in this field and their clients. The judge ruled on the protective measures as follows:
Entire agreement clause
EDS argued that an entire agreement clause in the original contract overrode any representations that they would have made previously, given that the agreement stated that it did “supersede any previous discussions, correspondence, representations or agreement between the parties” (emphasis added). The judge disagreed, holding that while it is an established principle that representations can be withdrawn or corrected, this was not done here. The representations may have been superseded by this clause, but the terms of the clause were not such as to amount to a “contractual renunciation” of the representations and as such they remained in place. Draftsmen take note: a representation must be killed, it cannot be relied upon to die on its own.
Waiver of contract claims in the Letter of Agreement
As part of the letter of agreement which formed the new understanding between the two parties, BSkyB had agreed to waive all “known claims and unknown claims” in contract against EDS. EDS argued that this included misrepresentation. Not so, said the judge. The clause was clearly restricting itself to contractual claims. Representation, including fraudulent misrepresentation is technically a tort however. While the losses that flowed from the misrepresentations were linked to the contract, they were not contractual claims but tortious ones and the judge would not allow the waiver to extend to such tortious claims.
Memorandum of understanding
At the end of the relationship, before litigation appears to have been decided upon, BSkyB and EDS entered into a Memorandum of Understanding which representatives from both signed. This was to smooth the handover between EDS and BSkyB’s own in house team SSSL. The agreement was expressed to be “subject to contract” and both parties envisaged concluding and signing a detailed contract in the future. A binding contract never materialised but the terms of the memorandum were far more congenial to EDS than any lawsuit from BSkyB would be, so their representatives tried to make the terms stick. This did not work, the judge holding that not only was the Memorandum of Understanding merely an agreement to agree, it after all said “subject to contract”. It was thus not a binding and enforceable agreement. Further, in order to hold it to be binding the court would have to have split the binding terms out from the rest of the memorandum.
Limitation of liability
Some good news for EDS can be found from the judge’s ruling on the effect of the limitation of liability provisions. Here, the judge held that BSkyB would be prevented from circumventing or escaping a contractual exclusion or limitation of liability by bringing a contractual claim by way of an equivalent claim in tort. Unfortunately for EDS, the judge upheld the general legal rule that such limitation clauses are not effective in claims based on the tort of fraudulent misrepresentation.
A claim for PWC?
The judge’s ruling on causation, that BSkyB would have engaged PwC to implement its own system but for the misrepresentations made by EDS prior to their selection, may open up a potential claim for PwC. In holding this, Ramsey J is suggesting that PwC suffered actual loss in the form of the lost profits they could have made from any contract with BSkyB. Further, as one of only three tenderers who responded to BSkyB’s invitation, their loss was foreseeable. There already exist a number of remedies in public law available to a disgruntled tenderer to an awarding public body. However, the statement by the judge may well provide PwC with a potential cause of action against EDS, a non public body.
Implications
EDS, in their amended defence, argued that:
“The points to which the Claimants refer are “risks,” which are commonly understood within the IT industry as anticipated potential challenges, to be avoided or managed. The Claimants have treated risks as if they were “issues”, ie currently manifest problems.”
To the relief of suppliers and perhaps the frustration of customers, the judgment does not appear to have given any greater rights to seek damages for the problems commonly associated with the implementation of IT and similar projects. EDS was not held liable for misrepresenting risks which they had discovered. Rather, it was held liable for both fraudulently and negligently making misrepresentations about whether they had properly assessed those risks. The law has not changed (although how it may apply to the implementation of such projects in practice has, perhaps, been clarified). Rather, we have been shown that the consequences of a fraudulent misrepresentation by one employee may be the company being held liable for a staggering sum of money.
Further, it is clear that the judgment has not opened the proverbial floodgates to dissatisfied customers, enabling them to routinely allege “fraud” as a way of circumventing provisions limiting recoverable damages. As is clear from the evidence regarding Joe Galloway, the facts of this case were (probably) exceptional.
Sales people should however take note of the consequences of making representations in the tendering process that are careless or not easily proven. Although BSkyB failed to make most of its allegations of fraudulent misrepresentation stick, it was able to overcome the threshold required to take such claims to court and argue them without a hint of criticism of this approach from the Judge in his verdict. Civil cases such as this cost time, money and are disruptive to the operation of a business, even if successfully defended and especially when they include allegations of deception.
The inevitable appeal (and change in the law?)
While the full figure of damages to be awarded to BSkyB is to be determined at a hearing in February 2010, BSkyB believe that they are likely to be awarded at least £200m. This is more than the limitation clauses would have restricted them to although somewhat less than the total £700m claimed by BSkyB.
HP (which now own EDS), continue to deny any accusations of deceit and are reported to have said that they intend to appeal the ruling. They are likely to hope that the appeal process does not take up as much time and money as the original trial did. Despite the length of the judgment, the long term impact of the decision may well be in doubt pending the outcome of any appeal which may result in a redefinition of the law on misrepresentation. The recent case of CBS v Dunlop Hayward, shows quite how far the courts are willing to go in terms of awarding losses suffered against those they have found to be dishonest.
Outsourcing Law & Business Journal™: December 2009
December 23, 2009 by Bierce & Kenerson, P.C.
OUTSOURCING LAW & BUSINESS JOURNAL (™) : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services. www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com for commentary on current events.
Insights by Bierce & Kenerson, P.C., Editors. www.biercekenerson.com
Season’s Readings (and Greetings) from Bierce & Kenerson, PC, Outsourcing-Law.com and our E-newsletter.
Holiday Greetings and welcome to this first edition of an exciting re-launched Outsourcing-Law.com™ website and e-newsletter! We want your feedback on the new Beta site as well as your contributions of content on international jurisdictions or legal issues in governance, risk management and compliance. Please contact us. See you in the New Year!
Vol. 9, No. 12 (December, 2009)
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1. E-Discovery and Legal Process Outsourcing: EDRM Process Design and Choices between Outsourcing vs. Insourcing
2. When is a Contractual Limitation of Liability Invalid and Unenforceable? American Public Policy Exceptions to Exculpatory Clauses in Telecommunications.
3. Humor.
4. Conferences.
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1. E-Discovery and Legal Process Outsourcing: EDRM Process Design and Choices between Outsourcing vs. Insourcing. State and federal rules of civil procedure and emerging common law of the discovery process impose significant costs on businesses that are engaged in litigation. Pre-trial “discovery” serves to narrow the issues in dispute by forcing the disclosure of records, including electronically stored information (“ESI”) for judicial economy, to narrow the scope of disputed issues for adjudication (such as through motions for partial summary judgment, admissions and prior inconsistent statements), and to speed the actual trial process. E-discovery has become a daily challenge for the General Counsel, the CIO, the COO and the Risk Management Department. They face a choice of policies, procedures and technologies for insourcing (such as by using forensic software and employed staff) or outsourcing for electronic records discovery management (“EDRM”) in e-discovery. This article explores some of the differences between insourcing and outsourcing in terms of records management / EDRM, legal requirements for protection and production of electronic records, project management in forensic record examination, litigation readiness, knowledge management, risk management, ethics and legal compliance. To see the complete article, please click here.
2. When is a Contractual Limitation of Liability Invalid and Unenforceable? American Public Policy Exceptions to Exculpatory Clauses in Telecommunications. An essential element of risk management in any commercial contract for the sale of services or goods is the clause limiting the vendor’s liability. In the sale of goods, the policy limitations are set forth in the Uniform Commercial Code, which invalidates clauses that deprive the customer of an “essential remedy” or the clause is part of an abuse of a consumer under a contract of adhesion, and under the federal Magnuson-Moss Warranty Act and similar state laws. In the sale of services, the policy limitations reflect common law, which may include a judicial analysis of regulations and the fundamental nature of the relationship between the service provider and the enterprise customer.
A decision by a New York State Supreme Court judge in November 2009 highlights the limits on exculpatory clauses under American jurisprudence under principles of gross negligence, willful misconduct, “special duty,” breach of the implied covenants of good faith and fair dealing and prima facie tort. In addition, other legal theories – such as fraud, intentional interference with business relationship, negligent misrepresentation, breach of the implied duty of good faith and fair dealing and prima facie tort – might not be available to enterprise customers for a simple failure by the service provider to deliver proper accounting information relating to its services. Click here for the complete article.
3. Humor.
Legal Process Outsourcing, n. (1) everything legal but not done by a lawyer; (2) everything done by a lawyer but not legal in your jurisdiction; (3) everything non-legal but legal because it’s paralegal.
Contract, n. (1) an enforceable expression of the meeting of the minds; (2) a meeting of the wallets
4. Conferences.
January, 24-26, 2010, IQPC Business Process Outsourcing and Shared Services Exchange 2010, San Diego, California. This is an invitation-only gathering for VP and C-Level senior Shared Services and Outsourcing executives made up of highly crafted, executive level conference sessions, interactive “Brain Weave” discussions, engaging networking opportunities and strategic one-on-one advisory meetings between solution providers and delegates. With a distinguished speaking faculty from McGraw-Hill, Ingram Micro and Pfizer, amongst others, the seats at the 2010 Exchange are limited and filling up quickly. We have limited complimentary invitations available for qualified delegates for a limited time. Please give us your reference ‘Outsourcing Law’ when inquiring. There are solution provider opportunities also available for companies who want to be represented. You can request your invitation at exchange@iqpc.com, call at 1866-296-4580 or visit their website.
January 28-29, 2010, Global Services Conference, Jersey City, New Jersey. Through the entire episode of the global economic meltdown, the global outsourcing services industry has seen the rise of a group of suppliers who are redefining many traditional management practices; changing the long-standing model for contracting offshore services; collaborating with clients in new ways; and gaining more control over outsourcing strategies. This conference focuses on these changes in the global services model and the learning from this period. For more information, visit their website
February 22-24, 2010, SSON and IQPC 8th Procure-to-Pay Summit, Miami, Florida focuses on “Fostering Smart Partnerships to Optimize Cash Flow and Deliver Positive Business Outcomes from End to End.” This Summit is all about making the most of your smart partnerships to increase cash flow and improve business outcomes as companies move away from a reactionary mode toward sustainable practices. While we may not yet be out of the woods, so to speak, it is clear that the economic landscape in 2009 has created opportunities for companies to create new synergies with their P2P partners to help promote growth for 2010 and beyond. For more information, click here.
February 24-25, 2010, IQPC’s 3rd E-Discovery for Financial Services Conference, New York, New York. Learn the Best Review, Retention and Destruction Procedures to Cut Costs and Response Time During a Financially Troubled Economy. This event examines, from the unique perspective of high-level financial executives, how the challenges of each financial sector intersect with e-discovery proceedings and processes. View the complete program agenda at www.ediscoveryevent.com/finance.
March 22-26, 2010, SSON presents the 14th Annual North American Shared Services & Outsourcing Week, Orlando , FL. Here’s a sneak peek of new and enhanced features, which include:
- Speakers from Top Companies:Aramark, Arbys/Wendy’s, AstraZeneca, Chevron, Coca-Cola, Conagra Foods, General Motors, Kellogg, Kraft, Microsoft, Monster, NASA, Northrop Grumman, Oakley, Perdue Farms, Schering Plough, Warner Brothers and more
- G8: Global Sourcing Think Tank Eliminating the White Noise: The first ever neutral platform to help shape a common industry agenda in the US
- Under the C-Suite Spotlight with Rene Carayol, An Exclusive Onstage CXO Interview : Board-room revelations regarding shared service & sourcing model strategy
- New, Strong, Business Outcome-Focused Content : 8 content-intense tracks, from Planning & Launching and BPO Evolution to IACCM’s Contracting to Collaboration
- Enhanced Annual Features: Quick Wins Energizers, Speed Networking, Blue Sky Innovation Room for Mature SSO’s, and more.
Please contact Kim Vigilia directly at 1-212-885-2753 or at kim.vigilia@iqpc.com with your special code IUS_OSL_#1 to get a 20% discount off the all-access pass. You can also visit the website at www.sharedservicesweek.com.
March, 25-26, 2010, American Conference Institute’s 4th National Forum on Reducing Legal Costs, Dallas, Texas. This essential cross-industry benchmarking forum gathers together more than 30 senior corporate counsel and legal sourcing managers responsible for cost-reduction success stories, as well as leaders from law firms who are pioneers in the alternative fee world, to guide those in attendance on the complexities of keeping legal department costs in check. Now in its fourth installment, this event also offers unique networking opportunities with senior practitioners in the field, includingin-house counsel across a wide spectrum of companies and industries. For more information, visit their website.
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FEEDBACK: This newsletter addresses legal issues in sourcing of IT, HR, finance and accounting, procurement, logistics, manufacturing, customer relationship management including outsourcing, shared services, BOT and strategic acquisitions for sourcing. Send us your suggestions for article topics, or report a broken link at: webmaster@outsourcing-law.com The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: publisher@outsourcing-law.com . Edited by Bierce & Kenerson, P.C. Copyright (c) 2009, Outsourcing Law Global LLC. All rights reserved. Editor in Chief: William Bierce of Bierce & Kenerson, P.C. located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.
When is a Contractual Limitation of Liability Invalid and Unenforceable? American Public Policy Exceptions to Exculpatory Clauses in Telecommunications
December 21, 2009 by Bierce & Kenerson, P.C.
An essential element of risk management in any commercial contract for the sale of services or goods is the clause limiting the vendor’s liability.
In the sale of goods, the policy limitations are set forth in the Uniform Commercial Code, which invalidates clauses that deprive the customer of an “essential remedy” or the clause is part of an abuse of a consumer under a contract of adhesion, and under the federal Magnuson-Moss Warranty Act and similar state laws. In the sale of services, the policy limitations reflect common law, which may include a judicial analysis of regulations and the fundamental nature of the relationship between the service provider and the enterprise customer.
A decision by a New York State Supreme Court judge in November 2009 highlights the limits on exculpatory clauses under American jurisprudence under principles of gross negligence, willful misconduct, “special duty,” breach of the implied covenants of good faith and fair dealing and prima facie tort. In addition, other legal theories – such as fraud, intentional interference with business relationship, negligent misrepresentation, breach of the implied duty of good faith and fair dealing and prima facie tort – might not be available to enterprise customers for a simple failure by the service provider to deliver proper accounting information relating to its services. So the “special relationship” theory (described below) merits special attention.
This court decision is a stark reminder that the autonomy of contracting parties is always limited by public policy. Enforceability of contracts thus must include contract planning and negotiation, express limitations on remedies and conformity to public policy exclusions that invalidate certain exculpatory clauses. This interplay sets the framework for risk allocation, contract pricing, performance standards, dispute resolution and competitive strategy for the enterprise customer and the service provider.
I. The “Special Relationship” among Telecom Carriers
The Duty of Connected Telecommunications Carriers to Each Other. In this case, Empire One Telecommunications Inc. v. Verizon New York Inc. (__ N.Y.S.3d ____, Nov. 2, 2009 NYLJ, p. 21, cols. 3-4), Justice Carolyn E. Demarest ruled that one service provider cannot rely upon its exculpatory clause when it has a special duty due to a special relationship with its customer. The decision goes beyond a simple analysis of claims that include gross negligence and willful misconduct, which have long been judicially viewed as exceptions to the normal rule that contractual limitations of liability are enforceable.
Historical Monopoly, Regulated for Competition. The Empire case reflects special character of telecommunications services as a regulated utility. In the Empire One case, Verizon and Empire One were competitors. By virtue of the historical breakup of the prior monopoly held by AT&T over a decade before, Verizon controlled the transmission equipment and lines that carried the telecommunications for Empire’s customers. Under the Telecommunications Act of 1996, 47 U.S.C. 151 et seq.), Verizon had a statutory duty to provide certain telecommunications services to competitors like Empire. Empire was a reseller of Verizon services. Empire was allowed by federal law to interconnect its own network (and other networks) with the Verizon network.
Implied Duties. Under the Telecommunications Act of 1996, Empire was entitled to control the business relationship with the ultimate consumer because Empire enrolled them as its customers and Empire’s own equipment delivered the final connection to the customer. Verizon was carrying calls that were originated with other carriers (such as but not limited to Verizon) that terminated using Empire equipment. Under the Telecommunications Act of 1996, as terminating carrier, Empire is entitled to bill the customer for the service and make a profit by charging the interconnecting carriers that originated the calls for using Empire equipment to deliver the “last mile” termination services. All calls are logged into the billing system of Verizon, since it acts as traffic controller. Verizon equipment, as the glue of the telecom system, is capable of providing information on date, time, origination and destination and the duration of calls as well as codes (LATA identifiers, a valid settlement code, a valid originating local routing number and other validation codes used in billing) that enables interconnecting carriers to bill each other for services.
Failure to Provide Billing Records. Empire complained that Verizon had manipulated the call records that it delivered to Empire by stripping essential information needed for Empire to bill other carriers. Empire alleged that Verizon rendered the call records “useless for the very purpose for which they are intended”. Empire complained that such omissions prevented Empire from determining the originating jurisdiction or the types of telephone calls (mobile, land-line), thus depriving Empire of the ability to charge the originating carrier for the termination services by Empire.
Damages. Empire alleged its losses from 2004 to 2008 were approximately $2,500,000 in lost revenue plus approximately $160,000 in payments to Verizon for unusable billing records covering over 15 million telephone calls. The Empire court provided a refresher course in the liability that a breaching party is deemed to assume. A breaching party “is liable for those risks foreseen or which should have been foreseen at the time the contract was made.” Ashland Mgt. v. Janien, 82 NY2d 395, 403 (1993), quoted at Empire, page 22, col. 1.
Elements of a “Special Relationship.” The decision focused on the conditions that established a “special relationship” between one telecom carrier to another that used its telecom transport facilities (the equipment and the lines) for a fee. The decision focused on the statutory structure regulating public utilities for the public benefit, which, the court held, supports a finding of a “special relationship” between the service provider with a monopoly over the billing records and the service provider that needed the billing records to bill other carriers. “Public policy as reflected in the regulatory structure would also mitigate against enforcement” of the exculpatory clause. The concept of “special relationship” has precedents under prior New York judicial decisions where a public utility fails to perform its duty to furnish reliable service.
Unequal Bargaining Power. Verizon argued that there is no “special relationship,” and therefore the exculpatory clause is valid, where the service contract was negotiated by two sophisticated parties who negotiated in a commercial setting. Rejecting this argument, the court ruled there was clearly an inequality in bargaining power between the two public utilities since, in this case, the terms were not actually negotiated. To promote the public interest under the Telecommunications Act of 1996, the court said, Empire as customer should be afforded the “protection generally due a consumer when dealing with a utility with monopolistic control of the desired service.”
Published Tariff Filing. The general public policy against exculpation of gross negligence and willful misconduct was also written into the particular tariff that Verizon had filed with the public utilities commission.
Service Provider’s Termination of Service following Unresolved Billing Dispute. Other precedents under New York law dealing with Verizon’s wrongful refusal to provision telecom services have ruled that Verizon is liable for consequential damages to a reseller of telephone services over lines provided by Verizon where (i) Verizon had billed and actually been paid for a telephone feature that it had not actually provided (a “billing error”), (ii) the customer stopped paying for the feature allegedly not provided, and (iii) Verizon cut off the reseller from its network for non-payment. The court allowed the reseller to pursue lost profits as consequential tort damages for gross negligence or willful misconduct.
II. Other Classic Causes of Action when the Service Provider Fails to Perform Proper Accounting Services for its Services Performed
Gross Negligence. Under New York precedents, “gross negligence” must “smack of intentional wrongdoing.” Kalisch-Jarcho, Inc. v. Cit of New York, 58 NY2d 77, 385 (NY 1983). Gross negligence evinces a “reckless indifference to the rights of others.”
Fraud. Fraud involves (i) a false misrepresentation as to a material fact, (ii) an intention by the defendant to deceive the plaintiff by such false misrepresentation, (iii) justifiable reliance by the plaintiff on the misrepresentation, and (iv) damages caused by plaintiff’s reliance. Empire claimed each of these elements but the court dismissed the fraud claim since fraud claims cannot be used to duplicate the same elements of a breach of contract, where the fraud claim was “collateral to the contract” and not based on the same facts alleged as to the breach of contract. A fraud claim is insufficient if it merely alleges that a misrepresentation of an intention to perform services under the contract.
Implied Duty of Good Faith and Fair Dealing. Under common law, there is an implied duty of good faith and fair dealing in the performance of contractual obligations. Here, Empire’s claim that Verizon breached this duty was dismissed since it was equivalent to a claim for breach of contract.
Tortious Interference with Business Relations. In the Empire case, Empire as CLEC customer claimed that Verizon as service provider had interfered with Empire’s business relations by its failure to provide the call data needed to enable Empire to bill its interconnect customers. This legal theory requires the injured party to allege and prove (i) the existence of the actual or prospective business relationship with a third party, (ii) the defendant, having actual knowledge of that relationship, intentionally interfered with it; and (iii) the defendant either acted with the sole purpose of harming the plaintiff or used means that were dishonest, unfair or improper, and (iv) the defendant’s conduct thus injured the plaintiff’s business relationship.
In the Empire case, this legal theory was unsupported. Empire was unable to validly claim that Verizon’s failure to provide interconnect customer billing information was directed to harm Empire’s customers, not merely to harm Empire. The court noted that Empire merely alleged that it was unable to invoice interconnect carriers for transiting its network due to the invalid and inadequate call records that Verizon sells to it. “Empire’s inability to bill these third–party carriers, however, would not induce these carriers not to do business with Empire.” Hence, Empire was unable to sustain a claim of intentional interference with business relationship.
Negligent Misrepresentation. Empire also claimed that Verizon was liable for consequential damages due to Verizon’s negligent misrepresentation. Such a claim depends on alleging and proving three requirements: (i) the existence of a special relationship or privity-like relationship that imposes a duty on the defendant to impart correct information to the plaintiff, (ii) the fact that the information was incorrect, and (iii) the plaintiff reasonably relied on the information to its detriment. It is a question of fact whether there exists a “special relationship” sufficient to justify plaintiff’s legitimate expectation that the information would be true and accurate. In this case, the tariff and the contract were worded in a manner that denied this type of special relationship to Empire.
Prima Facie Tort. Empire unsuccessfully alleged that Verizon was liable for “prima facie” tort, a unique common law tort theory under New York law. The requirements for alleging and proving such a cause of action include (i) the intentional infliction of harm, (ii) which causes special damages, (iii) without any excuse or justification, (iv) by an act or series of acts that would otherwise be lawful, and (v) that the disinterested malevolence was the sole motivator for the defendant’s harm-causing conduct. Empire failed to allege the last point, which it probably could not prove since reaping unfair profits is not an act of malevolence but rather an act of greed.
III. Lessons for Everyone
The Empire One decision was framed in the area of telecommunications and invoicing. Separate from the area of regulated public utilities, it offers nonetheless several practical lessons for structuring an outsourcing agreement:
- Exculpation is Limited. Public policy exceptions for gross negligence and willful misconduct are implied in every contract, whether or not included contractually.
- Mutually Agreed “Special Relationship.” A “special relationship” may exist, and the service provider’s exculpation might not be valid or enforceable, where the enterprise customer depends on the service provider to provision the service,
- Mutually Agreed Consequences. As a contracting matter, the parties should identify the consequences if the service provider suspends service while there is a dispute over adequacy of its provisioning of services, over billing for past services and for the customer’s inability to obtain alternative services in the spot market without consequential damages.
- F&A Services: Special Negotiating and Drafting Issues. Legal theories of fraud, intentional interference with business relationship, negligent misrepresentation, breach of the implied duty of good faith and fair dealing and prima facie tort do not give any remedy to the enterprise customer that loses revenue from an inability to use the service provider’s billing records to invoice its own interconnect customers. For “finance and accounting” outsourcing, this lesson means that inaccurate or insufficient accounting services need to be identified as a breach, and the quantum and conditions of “damages” for “direct damages”.
C&W US Clients Face Uncertain Future
October 9, 2009 by Bierce & Kenerson, P.C.
By Ed Agar, primesourcingadvisors.com
October 27, 2003 – The drama surrounding Cable and Wireless’ US hosting business remains an unresolved story for its approximately 1,500 clients. Since declaring its intention to exit the U.S. market in early summer, C&W has yet to deliver a clear update with regard to its business direction. C&W seems to be avoiding the inevitable.
Fundamentally, C&W was viewed to have two alternatives: sell the assets and existing contracts to an interested suitor, or declare bankruptcy. Andrew Schroepfer, founder and President of IT Infrastructure research firm Tier 1 Research (tier1research.com), says there may be a third hybrid option on the table. “We believe there is a buyer at the table for some of the marginally profitable data centers and the customer base where C&W would pay the costs to close down some of the other sites. Such an option would save C&W from the bankruptcy issues and save it several hundred millions of dollars from the option to pay to merely close the entire business.”
Most customers of the firm appear to have remained loyal thus far, which confuses Danny E. Stroud, former CEO of managed hosting firm AppliedTheory. “I don’t understand why CIOs, COOs and in-house counsel are not heads-down working on alternative service strategies – why executives are subjecting their valuable IT assets to significant risk exposure is irrational,” he says. “Since the financial shakedown of the last couple of years, there are now many quality providers. Further, with the availability of hosting vendor rankings like the PrimeSourcing Index there is a multitude of data to help buyers make informed decisions.”
The ‘wait and see’ attitude of C&W customers may be attributed to two factors: 1) customers have remained loyal due to renegotiated flexible terms and distressed pricing offers, and 2) transition efforts to a new provider are time consuming, costly, and rife with execution risks for resource-strapped IT departments.
Outsourcing lawyer Bill Bierce of Bierce&Kenerson PC and publisher of outsourcing-law.com (outsourcing-law.com), thinks current customer indifference is a highly risky approach. He recommends that CIOs review their agreements for termination and transition rights in case of bankruptcy. Should C&W opt for bankruptcy and the sheriff padlock the front doors, customers may be facing some nasty surprises:
- Assets could be locked down, forcing customers to petition the court to move their assets out. It would be expected that IT assets would be frozen a period from several days to several weeks, which is longer than the period of the typical disaster recovery service contingency plan.
- Bankruptcy could deprive C&W of the flexibility to service its customers in compliance with service level agreements. For managed services, the bankruptcy courts have the right to terminate executory contracts and not pay damages for wrongful termination.
- Customers may need to get a license to continue to use software licensed by C&W. The US Bankruptcy Code allows the bankrupt service provider to terminate a service but does not require it to allow the user to get access to any software that was used in providing the service.
- Where a bankrupt managed service provider abuses its credit lines with its own suppliers, paying customers have no assurances that funds will flow downstream to subcontracted suppliers or even if subcontractors will be retained by the bankruptcy courts. As the cash cycle stops, the services may stop, too.
How C&W will respond to its obligations will be played out in the coming months. The experience of Exdous, Intel Online Services, WiTel, MFN, PSInet, Genuity, Northpoint, Rhythms, Network Plus, Winstar and others exiting the data center market has been mixed. In some situations, there have been documented examples of looting, destruction of property, stranded customers, and total withdrawal of services accompanying a dark data center. “Some customers were forced to take extraordinary steps under duress to insure service continuity, while other customers sustained revenue loss and productivity hits,” Stroud says. “Further, costs and performance degradation during a hasty transition to a new provider are generally significant.”
Stan Lepeak, VP of Meta Group Inc. (metagroup.com), a research firm, says the best hope for customers “is a prepackaged bankruptcy that allows the customer relationship to be bought by a ‘white knight’ with the court’s blessing. This process allows the shedding of liabilities.” There must be reasons why suitors have not already grabbed C&W’s US assets for pennies on the dollar. In simple terms, this would seem to indicate the business does not appear to be salvageable and that a clean buyout seems unlikely.
Given the above scenarios, it is recommended that prudent executives start to invoke contingency plans. According to Schroepfer, “aside from acknowledging that avoiding a migration is a good thing, we would move our own operations out of C&W if we were there.”
It is recommended that exit strategies be planned with the assistance of independent hosting consultants and specialized attorneys. Such trusted advisors are needed to understand the ramifications of outsourcing contracts. A critical element that hosting advisors are now assessing in selecting new providers is the vendors’ implementation of quality initiatives like ISO 9001, IT Service Management or Carnegie Mellon’s e-Sourcing Capability Model.
As a next step, Global 2000 firms should identify their degree of risk exposure to their internal audit committees in order to determine applicability for disclosure in SEC filing as part of Management’s Discussion and Analysis forms in compliance with the Sarbanes Oxley Act.
C&W is due to report its mid-year financial results in November, and it is also expected that they will communicate their future direction and intentions at that time. One can anticipate that the competition will feature attractive incentives and deeper price discounting in order to woo prospective C&W clients.
As an observer, it will be interesting to see if C&W clients will be enticed by price incentives or if there will be a ‘flight to quality’. Time alone will tell.
About the author
Ed Agar is co-founder and Principal of PrimeSourcing Advisors, an IT advisory firm. For more information, visit primesourcingadvisors.com.