The recent case of Medirest -v- Mid Essex Hospital Services NHS Trust, concerning the provision of hospital catering, will be of interest to anyone involved in outsourcing services, particularly in the NHS.  It contained little by way of new law, but it does provide a useful case study (as well as asking the intriguing question, what price can be put on an out-of-date chocolate mousse). This article makes some practical suggestions as to how the lessons from the case can be applied by Trusts and suppliers when approaching their outsourcing contracts.

The facts can be simply summarised.  Medirest took over responsibility for the catering services at a number of the Trust's sites in April 2008 under a contract with an initial term of seven years.  There were some modest teething troubles in the early stages, but these were resolved relatively quickly so that by early 2009 there were high levels of patient satisfaction, and food hygiene and cleanliness were found to be good in all areas.  However, the Trust took a hard line on the identified contractual breaches occurring in 2008 and sought significant service fee deductions under the performance monitoring regime (around £590,000 for a 6 month period, representing over half of the whole service fee payable for that period).  These deductions were disputed by Medirest, and attempts to reach agreement on the appropriate level of deductions led to a souring of the relationship.  In the end first Medirest then the Trust served termination notices.

The case centred around whether the parties' respective termination rights had been properly exercised.  The judge concluded that both parties were entitled to terminate the contract, but awarded neither side substantive damages.

So what lessons can be learnt?

1. Apply common sense when interpreting a contract

If a clause in a contract is open to different interpretations, the court will generally adopt the interpretation which most closely accords with commercial common sense.

A strange aspect of this case, one that is not explained in the case report, is why the Trust behaved in the confrontational manner that it did, almost from the outset. Whilst the judge noted that there is nothing wrong with a challenging approach in managing a contract, he added that it is necessary to deploy fact and common sense.  Contrary to that requirement, important calculations in the Trust's fee deduction claims were described as patently absurd - for instance, £84,540 was claimed for a chocolate mousse that was one day out of date, £46,320 for a box of old ketchup sachets (probably dating back to the previous service provider and never used by Medirest) and £96,060 for some 3 day old bagels belonging to staff or patients.

2. Don't underestimate the value of good faith obligations

The case turned on the contractual requirement that the parties cooperate with each other in good faith to enable the Trust and other beneficiaries to derive the full benefit of the contract.  It is easy to dismiss such an obligation as being too vague to have any value ("a general wishy-washy duty to be nice in all communications" was the phrase used at one point in the trial by the Trust's legal team) but in fact it acted as the peg on which Medirest could hang their claim of unreasonable behaviour by the Trust.

It was also interesting that the judge chose to apply the duty of good faith in the context of the common purpose of the contract, namely the provision of service to patients and visitors to the hospital.  The Trust was not acting in good faith because its actions were likely to damage the relationship with Medirest and thus undermine the benefit which patients could derive from the contract.

3. Where a contract gives a party a discretion, that discretion should be exercised reasonably.

It is often in the nature of the tender process that bidders are presented with the terms and conditions of contract on a "take it or leave it" basis, with little scope for negotiation of the legal detail.  One type of provision that can be of particular concern to bidders is that which purports to enable the other party to make determinations under the contract in its absolute discretion.  However, such a provision should not be taken at face value and the party having the discretion should expect to have to exercise it honestly and in good faith - the judge agreed that an implied obligation not to act in an arbitrary, irrational or capricious manner was likely to be implicit in any commercial contract under which one party is given the right to make a decision on a matter which affects both parties whose interests are not the same.

In this case, Medirest had to demonstrate to the satisfaction of the Trust that a performance failure had been remedied in order to stop service fee deductions clocking up for it.  The Trust insisted that it could only be satisfied if it received an email or the like that the fault was remedied.  In several instances, although a fault was remedied in the presence of senior Trust staff, the Trust asserted that it could not be satisfied that a fault had been remedied and continued to calculate service failure points because no email was received.  That was held to be unreasonable behaviour on the part of the Trust.

4. Use the  performance monitoring regime for its proper purpose

As one would expect, the contract contained a number of key performance indicators (KPIs) to monitor the quality of the service that was being provided. These should really be used as a means to ensure performance is at the level needed and to identify areas for improvement.  It is hard to get away from the impression that one of the Trust managers was attempting to use the KPIs as a means to reduce the contract price - at one point, Medirest were asked something along the lines of "how much do you want to pay to retain the contract?"

5. Make sure the KPI regime works in practice

One of the reasons why it was possible (however tortuously) for the Trust to calculate such large services fee deductions, was that the regime countenanced the possibility of multiple penalties for the same infringement, accruing on a daily basis.  Consider whether that is appropriate.  It is also important that KPIs are precise and unambiguous, for instance as to what constitutes a single breach - one of the KPIs in this case required "areas" to be cleaned, and the Trust contended (unsuccessfully as it happens) that each dirty cooker, toaster and so on constituted a separate "area". It is always worthwhile running a few practical examples to test that particular levels of non-compliance result in a sensible quantum of fee deductions relative to the overall contract price, and that there is not the possibility of, for instance, a single occurrence attracting deductions from a number of different KPIs.

Also, where termination is permitted once the number of service fee deductions reach a certain level, take care that the threshold chosen is set at an appropriate level, so (from a supplier's perspective) it is not triggered by only trivial non-compliances, but equally (from a customer's perspective) it is not so high that major meltdown would have to occur before the termination right can be exercised. In this case, the Trust were entitled to terminate because the contractual threshold was exceeded, but the facts would suggest that the threshold was too easily reached.

6. Expect it to take time for the services to settle down

Outsourcing contracts are usually on a large scale, with much for the new supplier to get to grips with.  Therefore, it is to be expected that there will be some teething problems in the early stages, particularly if unfamiliar staff are transferring to the supplier under TUPE.  It is likely to be for the best in the long time if allowances are made for this, and the customer isn't heavy-handed in the exercise of its strict legal rights (provided, of course, that leniency doesn't compromise patient safety) - one of the most unfortunate aspects of this case was that, when the relationship broke down, the service was actually working well, and the parties were arguing about history, i.e. early breaches of the KPIs in the previous year.

From the supplier's perspective, it would be preferable if the idea of a bedding-in period is enshrined in the contract: for instance not making it liable in the early stages for problems which it inherits and, as in this case, having a grace period before service fee deductions start to apply.

7. Understand your contractual obligations

This may seem like a statement of the obvious, but one of the reasons why the relationship got off to a bad start was that Medirest failed to appreciate the nature of the 3 month bedding in period which the contract allowed.  During this period the service fee deduction regime was suspended, but Medirest also mistakenly believed that the reporting regime did not apply during that period either and so failed to provide the Trust with the performance information it was expecting.

8. Don't use an inappropriate starting point for your contract

In this case the contract took the form of a standard NHS contract coupled with a performance regime taken from a PFI precedent, even though the catering service was not a PFI project.  The judge said that the cobbled together nature of the contract did not assist its use by the staff of either party.

9. Consider defining what represents a material breach

The contract entitled Medirest to terminate for material breach, but was the Trust's breach sufficiently serious to count as "material"?  This is always a difficult decision for a contracting party to take because of the imprecise nature of the term.  In some instances the uncertainty can be reduced by quantifying materiality - for instance specifying a monetary threshold, or by stating that any breach of certain clauses will amount to material breaches.

For areas where is not appropriate or possible to do this (for instance, because the consequences of breach cannot be assessed in monetary terms) there were a few pointers in the judgement:

  • materiality is to be judged objectively by reference to all the facts;
  • "substantial" and "material", depending on the context, are interchangeable;
  • in assessing materiality, one must assess: the actual breaches; the consequence of the breaches to the innocent party; the guilty party's explanation for the breaches; the consequence of holding the agreement as terminated and the consequences of holding it as continuing.

The Trust's breaches were deemed to be material on the grounds that: its behaviour was likely to result in a breakdown in the relationship; it acted in a manner calculated, at least objectively, to impose the largest possible service penalties irrespective of justification; the commercial effects of the breach were substantial, the claimed penalties amounted to a significant part of the contract turnover, making it commercially unworkable; there was no sign that the Trust intended to soften its approach; and there was substantial ongoing uncertainty as to whether Medirest would be paid for its services.

10. If at all possible, resolve disputes without resort to litigation

This case is a good demonstration of the old adage that, in litigation, only the lawyers win.  Because both parties were entitled to terminate the contract, neither could succeed in their substantial claims for post termination losses.  Undoubtedly, both parties would have ended up significantly out of pocket as a result of the dispute.Outsourcing usually involves a long term commitment.  It stands a far better chance of being successful and productive on all sides if the parties are able to develop a trusting and positive working relationship.