IBM v Co-op – When digital transformation projects go wrong

Cases involving large-scale IT contracts are quite rare and the recent case of CIS General Insurance Ltd v IBM United Kingdom Ltd* provides a useful judgment for matters involving digital transformation projects which have gone wrong.

Background
This case involved an IT contract between IBM and CIS General Insurance Ltd, whose trading name is Co-op Insurance (Co-op), for the development of a new insurance underwriting system.

The parties entered into a £50m IT contract as part of a digital transformation project and in order to deliver part of the project, IBM sub-contracted some of the services. Delivery of the project was time-sensitive and IBM’s sub-contractor majorly underperformed; there were delays in the project causing key milestone dates to be missed, and the coding was buggy, among other issues.

Although this meant that IBM was in breach of the contract, Co-op decided not to terminate the contract with IBM after it had failed to remedy the breaches when provided with a notice of breach. Instead, when payment of an invoice became due, which was worth around £2.8m, Co-op withheld the payment stating that they were off-setting the damages from IBM’s breach from all future invoices.

IBM subsequently terminated the contract and brought the project to an end. This was a high-risk strategy for IBM and it was thought that continuing with the project would have resulted in substantial losses to IBM. The contract contained a limitation of liability clause and IBM took the risk of wrongfully terminating the contract and relying on this clause to limit its financial exposure as it would have been cheaper than finishing the project.

Co-op made a claim of £128m for wasted expenditure for IBM’s wrongful termination of the IT contract as well as other claims in relation to breach of warranties, delays in the project as well as a delay/failure to accurately report on the progress of the project.

Did IBM have the right to terminate the IT contract?
Under the contract, IBM only had the right to terminate if there were undisputed invoices over a certain amount that remained unpaid for over 40 days. Co-op had seven days to dispute an invoice and they were able to set off sums payable due to breach of contract. The court decided that Co-op was able to dispute this invoice and, as a result, IBM had wrongfully terminated the contract.

Damages for wasted expenditure  
Whilst it was found that IBM had wrongfully terminated the contract, the court did not allow Co-op’s claim for £128m in wasted expenditure. In this case “wasted expenditure” was deemed to mean the same thing as a claim for “loss of profit, revenue and savings”, which were expressly excluded in the contract and therefore could not be recovered.

Here the court referred to another case[1] and explained that the loss of bargain that Co-op suffered due to IBM’s breach amounted to the savings, revenues and profits it would have received if the IT project was successfully implemented. The court decided that although Co-op phrased this as a claim for wasted expenditure, it was ultimately just another way of quantifying its compensation for loss of profits, revenue and savings – the court reasoned that the characteristics were the same.

Liability cap
Although Co-op was unsuccessful in its claim for wasted expenditure, it was able to successfully claim that IBM had breached the contract for the delay of key milestone as well as breaching its reporting obligations to communicate the delays with Co-op.

However, the contract contained a liability cap for IBM that was significantly lower compared to the overall cost of the project. Co-op had tried to override the liability cap by arguing that IBM had purposely defaulted the contract through wrongful termination due to the costs involved in continuing the project. However, Co-op failed to demonstrate this to the court which meant that they could not override the liability cap.

As a result, Co-op was awarded £15,887,990 in damages, which matched IBM’s cap on liability. IBM was entitled to the payment of the disputed invoice of £2,889,600 and this was taken off from the sum awarded to Co-op.

Key findings from this case
Both parties suffered substantial losses and it is arguable who is truly the winner of this case. Although it was found that IBM had wrongfully terminated the contract and Co-op were awarded damages, the damages awarded were significantly lower than what Co-op had initially claimed and, above all else, Co-op never received the benefit of a new IT system. IBM had to pay substantial damages, but ultimately the costs of these damages were lower than completing the IT project.

Whilst the result of this case may be surprising for some and it is likely to be appealed, this case shows the importance of clearly worded and negotiated IT contracts. Organisations looking to update their IT infrastructure or invest in new technology should take care when entering into these contracts as they are typically high-value and should be appropriately reviewed and negotiated.

Key points for organisations to consider when entering into IT contracts include:

• Limitation of liability caps – what losses are excluded under these clauses? Is a cap set at a level that makes it is easier for a party to purposely breach the contract and walk away, rather than perform its obligations?
• Milestones – should payment of invoices be dependent on milestones? Is this clearly stated in the contract?
• Payment – should payment be linked to the party not being in breach of the contract?
• Reporting – are there clear obligations for a party to report delays in the project in a timely manner?
• Termination provision – are you satisfied that the contract is clear regarding the events where the parties may terminate the contract?

For more information

If you would like any advice surrounding your IT contracts and how to best protect your organisation when entering into digital transformation projects, please get in touch with your relevant ACS contact or Rumandeep Dhariwal.       

[*] CIS General Insurance Ltd v IBM United Kingdom Ltd [2021] EWHC 347 (TCC)
[1] The Royal Devon and Exeter NHS Foundation Trust v ATOS IT Services UK Ltd [2017] EWHC 2197 (TCC)

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