The risks of playing hardball when enforcing outsourcing contracts

Summary

The recent case of Compass Group UK and Ireland Ltd v Mid Essex NHS Trust [2012] EWHC 781 (QB) provides an instructive reminder of the need for parties to cooperate in long-term service contracts such as those for IT outsourcing. The case shows how aggressive approaches to enforcement can easily backfire and breach contractual obligations to cooperate in good faith. It also serves as a reminder that discretionary remedies must be exercised reasonably.

Introduction

A long-term outsourcing contract for IT services is much like a marriage: each party enters into the contract promising much and (usually) with the best of intentions. As the years roll by, little niggles about performance creep in, but because each side is in it for the long haul, they understand that these things must be worked through together.

Although the facts of this particular case relate to a dispute over a hospital facilities management contract, it has relevance for a much wider range of contracts. The key points are directly applicable to IT outsourcing, or any other business process contract where complex services and service credit mechanisms come into play. The case also provides useful guidance over how duties of good faith will be interpreted in such contracts.

Background

The contract in dispute was a long-term facilities management contract between Compass Group (trading as Medirest) and Mid Essex Hospital Services NHS Trust. Medirest was responsible for supplying and serving food, hospitality, vending machines, cleaning, and providing a helpdesk facility for these services.

Implementation of the contract did not go well from the start. Despite a TUPE transfer there was a shortage of Medirest staff, especially team leaders. Almost immediately, the Trust took an aggressive stance on enforcement. Within a week of service commencement (notwithstanding a three month bedding-in period) the Trust’s commercial director (who devised the contract) requested a copy of the contract because, in his words, the relationship “could get contractual”. Shortly afterwards, he instructed a colleague to “read the riot act” to Medirest, who in turn told his team to review Medirest’s action plan and “pull it to bits”.

Medirest’s service failures services in the first few months resulted in a claim by the Trust for deductions of £587,207.67, which was over half of the entire service fee payable for that period.

This included large deductions for an out-of-date box of ketchup sachets found in a cupboard (£46,320 deduction) and for a refrigerator with no temperature display (£94,830 deduction). The judge called the Trust’s calculations “patently absurd”.

Notwithstanding this rocky start, within 5 months the services had improved such that there were no longer significant problems with delivery. However, by maintaining its extreme calculations and demands, the Trust had effectively destroyed the working relationship between the parties. As a result, within 18 months of service commencement, both sides purported to terminate the contract for default.

It was held that both parties were entitled to terminate the contract. Although Medirest’s service failures had triggered a right for the Trust to terminate, the Trust was also found to be in material breach of contract due to its stance on calculating the deductions and making demands for payment, and for maintaining these demands well after it should have realised they were unjustified.

Implications for applying service deductions

With hindsight, it is difficult to imagine how the Trust believed that it was acting reasonably in seeking to enforce the payment mechanism so aggressively for what the judge found to be relatively minor infractions. However, the case highlights that where a party “gets contractual” and elects to take a strictly legal approach to enforcing contractual terms, common sense can sometimes fly out the window.

Although the actual deductions in this case were almost ludicrous in nature and size, it would not be unusual to find similar calculation mechanisms in an IT contract to deal with outages, missed fix times, or an unresponsive helpdesk. This is particularly true of PFI-style contracts where repeated or continuing failures can result in deductions being ratcheted up by a multiplier.

Significantly, the judge held that the contractual language conferred a discretion - not an obligation - on the Trust to levy deductions. He held that such discretion must not be exercised in an arbitrary, capricious or irrational manner, which the Trust had done by refusing to accept that its inflexible approach and inflated calculations were fundamentally flawed, despite many months of complaints from Medirest.

Complex service credit regimes can produce extreme results, especially where implementation is delayed or where there are shortages of skilled staff, so it is important to look at the whole picture before applying them. When problems arise, a purchaser of services must take care not to read discretionary remedies as absolute rights. When applied without common sense, the black letter application of service credit mechanisms can ultimately destroy the parties’ working relationship to the disadvantage of all concerned.

Impact of good faith

IT service providers also increasingly have to grapple with duties of “good faith” similar to those imposed by the Trust. Even though it is often stated that there is no concept of a duty of good faith under English law, it creeps into drafting on a surprisingly regular basis. It will often be as a result of tender documents and standard form contracts being influenced by big US and continental European players; sometimes it will be included as part of an eleventh-hour compromise in order to try to soften a contentious point. Either way, its application can be unpredictable for both parties.

The judge found that the Trust’s behaviour, including a breach of the obligation to cooperate in good faith, constituted a serious and continuing breach of its critical obligations, which went to the very heart of what was meant to be a long-term contract requiring cooperation. The duty to cooperate in good faith is to be informed by the nature of the relevant contract and a key factor is the length of the contract. In a long-term contract the parties should anticipate that problems might occur from time to time and that these need to be worked through together. An obligation to cooperate in good faith means that the parties are also obliged not to take unreasonable actions that could poison their working relationship.

An additional factor in this case was that there was a common purpose under the contract of conveying a benefit to the public. The conduct of each party had to be faithful to this common purpose. It was therefore not open to the Trust to interpret an obligation to cooperate in good faith in a restrictive way.

Comment

The case highlights the need for both service providers and purchasers to cooperate in connection with their performance. Parties must also not lose sight of the fact that where there is a general obligation to cooperate in good faith this will affect how the parties can exercise any discretion. The purpose of the contract may also need to be factored into this equation, particularly where service failure can affect important public policy issues such as patient care.

Tellingly, the judge singled out the Trust’s commercial director as having prime responsibility for the unfortunate situation. Another lesson to be learned from this case is that no matter what is written into the contract, it will ultimately be for an individual to apply the words and it can be easy for that individual to become entrenched in a position from which it can be difficult to escape. The bullish language of the Trust, quoted throughout the judgment, underlined its failure to act in good faith. In such cases, both sides should take care to show that their approach is rational and, particularly where there is an obligation to act in good faith, that this is not undermined by inflammatory rhetoric.

All this is not to say that a party is never entitled to take a “challenging” approach to managing a contract. Despite the extreme circumstances of this particular case, the judge took care to emphasise that a party is entitled to adopt such an approach - even where there is an obligation to cooperate in good faith - so long as that party deploys the facts and a healthy dose of common sense.