KPI framework was contractually binding

In Sutton Housing Partnership Limited v Rydon Maintenance Limited [2017], the Court of Appeal held that figures contained in a framework of key performance indicators (KPIs) in a contract amounted to a legally binding minimum performance commitment.

What happened?

Sutton Housing Partnership (SHP) manages housing stock in the London Borough of Sutton. SHP engaged Rydon under a contract to carry out maintenance and repairs to some of that housing stock. The contract was based on a construction industry standard form.

The contract contained a mechanism allowing SHP to require Rydon to improve performance if it failed to meet certain "minimum acceptable performance" standards ("MAPs"), and ultimately to terminate the contract if it did not. The MAPs were defined by reference to KPIs set out in a "KPI Framework". The contract also provided for Rydon to earn bonuses if it exceeded the MAPs.

The KPI Framework set out various categories of KPI linked to the punctuality and quality of repairs and residents' satisfaction with the repairs. It also contained "targets" for the various KPIs, as well as three spreadsheets showing example scenarios where performance exceeded all MAPs, failed to meet all MAPs, and exceeded some MAPs but failed to meet others. However, the framework did not expressly refer to the MAPs.

In November, SHP sent notice to Rydon stating that Rydon had failed to meet the MAPs under the contract in relation to five out of the seven KPIs. SHP invoked the performance improvement mechanism and, when Rydon failed to improve performance, served notice to terminate the contract.

Rydon responded that the contract and KPI Framework did not in fact specify any MAPs, and that SHP had terminated the contract unlawfully. SHP argued that the targets set out in the KPI Framework constituted the MAPs.

The High Court agreed with Rydon and found that the contract did not contain MAPs. SHP appealed.

What did the court decide?

The Court of Appeal agreed with SHP. In particular, the judge said that SHP and Rydon must have intended for the contract to contain MAPs, because otherwise SHP would have lost a "valuable mechanism for termination" and Rydon would not have been able to calculate its bonus entitlements. In particular, he said that the parties could "hardly have intended to neutralise the principal contractual provision enabling [SHP] to terminate for poor service".

Although the only place where MAPs appeared was in the three so-called "examples" in the KPI framework, the Court felt that the parties must have intended for these figures to be the actual MAPs for the year in question, and not merely hypothetical MAPs by way of illustration.

The Court therefore held that the figures set out in the KPI Framework were binding.

Practical implications

Although this case concerned a housing repairs contract, the principles of the decision will extend to contracts in many other areas. The use of KPIs, service level agreements (SLAs) and other minimum performance criteria is common in commercial contracts generally. KPIs are also sometimes found in transitional service arrangements on business disposals and in joint venture agreements.

More broadly, it has become increasingly common to include worked examples of calculations in contracts in an attempt to better explain or illustrate complex calculation or valuation provisions. This is not limited to KPIs, but, for example, may extend to calculating purchase price adjustments, share valuations, investment returns, IRR hurdles, share subscription entitlements and ratchet mechanisms.

Worked examples of these kinds can be tremendously useful. However, if the parties intend to include examples only as illustrations, and not as binding contract terms, it is important to make this clear in the contract itself. A common way to achieve this is to include language stating that any worked examples are "for the purposes of illustration only" or "by way of example and without prejudice to" the specific parts of the contract that specifically define the KPI, hurdle or other metric.

The wording of the contract in this case clearly made the judge's decision easier. The contract clearly defined the MAPs by reference to the KPI Framework, so inviting the court to identify some figures in the framework as the agreed MAPs. Other cases, however, will not be as clear cut.

On a related note, if including worked examples in a contract, it is also important to always ensure that those examples do in fact follow the calculation methodology set out in the contract, and that the worked examples are themselves consistent with each other. Any discrepancies between worked examples and the calculation methodology will only provide further ambiguity and may invite a court to enquire deeper into the figures in the contract.

Other items

  • The International Accounting Standards Board (IASB) is seeking views on IFRS 13 (Fair Value Measurement) to assess whether IFRS 13 is meeting its objectives. Particular topics of focus include whether fair value measurement disclosures are useful, measuring quoted investments in subsidiaries, joint ventures and associates, the concept of the `highest and best use' for non-financial assets, measuring value in absent markets and whether support would be of benefit in applying judgement. The IASB is requesting responses by 22 September 2017.
  • The European Securities and Markets Authority (ESMA) has published updated Q&A on the Alternative Investment Fund Managers Directive (AIFMD). The new Q&A explain how fund managers should report on the breakdown between retail and professional investors, how they should provide information on funds domiciled in other EU Member States and to what extent fund managers use the intra-group exemption from their general clearing obligation.
  • ESMA has also published an updated Q&A Market Abuse Regulation (MAR). The updated Q&A includes a new question on whether a blanket order cancellation policy constitutes insider dealing under MAR (question 4.1) and a new question on whether MAR requires credit institutions to systematically publish the results of a Pillar II assessment (question 5.1).

The answer to question 5.1 also contains a reminder that where the disclosure of inside information has been delayed by a company and the inside information subsequently appears in a publication that did not come from the company (such as an article or internet post) or in a rumour in the market and the information is sufficiently accurate to indicate that the confidentiality of the inside information is no longer ensured, the company is expected to react and respond. The answer makes clear that a policy of staying quiet or "no comment" is not acceptable; the reaction or response should be made publicly available without undue delay using the same mechanisms as those used for the communication of inside information.