Getting technology contracts right

Your guide to avoiding the pitfalls

This article is essential reading for both buyers and suppliers of technology and discusses some key points for getting technology contracts right.

Here, we focus on the supplier's perspective but, by definition, that also indicates important points for buyers.

1. Pre-Contract Issues

(i) Do you need a contract?

Whether you are a customer or a supplier of technology goods and services, you need an appropriate contract for every deal.

Businesses, technology itself and (importantly) the legal background are all constantly evolving and this means that nothing is "standard".

Also every deal has its own legal, commercial and financial issues. For example the relatively new trend known as utility computing (in essence meaning that customers share resources and suppliers charge customers only for resources actually used) is a change that will impact on technology supply contracts where a supplier wants to charge on a utility computing basis.

So because of constant change you do need a contract and the contract must be appropriate to the circumstances. Any business that just signs on the dotted line is asking for trouble.

(ii) Contract management

The purpose of a contract is simple: to represent as closely as possible, in writing, the deal agreed between the parties.
That purpose is lost if a contract is stuck in the filing cabinet and forgotten.

Deals can change and often contracts should be treated as a work in progress and reviewed and updated.

As a supplier you must be quite clear before you sign a contract on what the customer wants and who has responsibility under the contract. Are you as supplier taking responsibility for providing a system or services to the customer or does the customer's IT department want some control or total control (for example on procurement decisions)? Suppliers don't want to be in a situation where the IT department is telling you what to do but you have responsibility if it all goes wrong. Split responsibility can lead to disaster.

(iii) Pre-contract Statements/ Written records

Remember that pre-contract statements may become a term of the contract itself.

Also any letters, memos and e-mails must be disclosed in legal proceedings if they are relevant to the issues in a dispute (even if they are marked "private and confidential").

Statements made in a pre-contract letter helped achieve success for a Taylor Walton client recently. The client was an advertising agency which bought a new agency management software package. The client did make clear in pre-contract negotiations that a number of functions were essential. The system failed to achieve these functions and our client issued a claim for a five figure sum being the purchase price and damages. An important argument for the client was that the supplier had confirmed in a pre-contract letter that the system would achieve the essential functions and that the letter formed part of the terms of the contract. Our client settled the claim and the supplier repaid nearly all of the purchase price.

So, beware of "sales talk" before the contract is signed and of recording anything in writing that you would not be happy to read in a court of law.

2. The Contract

(i) Offer/ Acceptance

First things first. You need to be sure that your contract terms are part of the contract at all. The terms that are "on the table" at the moment you accept an offer are the only terms that apply.
If you accept an order on the telephone, by post, by fax or on a website and do not make it clear that terms apply then the terms are probably not a part of the contract at all.

Some very big companies fall into this trap: Kodak advertised £300 digital cameras on its website at a price of £100 for a few hours in 2002. Thousands of orders were placed by the time Kodak corrected the error. It was reported that Kodak initially refused to supply the cameras saying in correspondence that "all offers placed on the website legally constitute offers to purchase from us" and that Kodak was "entitled to accept or reject them". In fact it is reported that Kodak's website automatically confirmed receipt of the orders using wording that was considered to amount to legal acceptance. At least one customer threatened a lawsuit and Kodak ultimately agreed to supply the cameras.

This is reported to have cost Kodak about two million pounds.
For suppliers it is essential to clarify how and when orders will be accepted and contracts made.

We have a free information sheet on contract making procedures - feel free to email me and I will send a copy.

(ii) Services/ Price Reviews

We often recommend that technology contracts allow some mechanism for making changes to the scope of services.

Suppliers should consider how flexible they are prepared to be and the risks of flexibility. A straightforward example is, if the contract says that the supplier will service all the customer's offices and the customer opens offices abroad then the contract may become unprofitable.

There was a temptation in the past for suppliers to shy away from detailed written service level agreements (or SLAs) on the basis that if no particular measure of efficiency was agreed in writing then it would be difficult for the customer to sue on unfulfilled expectations. Where the obligations of the supplier were not clear from the SLA the courts tended to lean over backwards to help the customer. There is an advantage to suppliers in agreeing a detailed SLA that confirms what is in and out of the box. Customers may prefer less detail and would usually be happy if the SLA says simply that "the supplier will supply all IT services required by the customer". A good SLA will reflect common sense project discussions and seek a balance of interests.

Pricing may need to adapt to any changes in services or SLA's. In technology contracts pricing is often fixed price or time and materials. If prices are fixed over a period then price increases will need consideration (customers will often seek to limit increases to the rate of inflation or an agreed percentage).

The answer may be an appropriate change control procedure in your contracts which can be used to vary the scope of services and pricing. Of course it is preferable that any change is at the supplier's discretion rather than the customer's.

(iii) Specification

If things go wrong, one of the documents a lawyer will look at is the specification as it should help to define in as much detail as possible the output required.

If your contract includes a specification, get it checked by a technology lawyer. I am not suggesting that lawyers should get involved in considering the technical content of Specifications but they should at least check that the Specification is clearly a part of the contract. Our litigation team has advised on cases where one party wants to rely on the content of a Specification but couldn't because it was not a part of the contract at all.

(iv) Intellectual property

By intellectual property I mean valuable information and ideas, as well as the more familiar registered intellectual property rights (such as patents, trademarks, designs) and unregistrable intellectual property rights (such as confidence and copyright).

A supplier should in all contracts (at the very least):

(a) Protect any intellectual property that forms part of its core business.

(b) Agree (at the outset of the deal) either ownership or at least a licence to use intellectual property developed during the course of the contract. That is particularly important if the development of the intellectual property is funded by the customer as there may be a presumption that the customer owns it.

(c) Remember that there may also be third party intellectual property rights which are licensed to the customer. If so the supplier will need a licence to any third party intellectual property which it needs to access in order to supply services.

Check that at least these three elements are considered in all technology contracts and there may be more: intellectual property can be one of the more complex parts of a contract.

(v) Software licensing

Customers tend to regard themselves as buying a perpetual right to use software. But suppliers will seldom (if ever) give an unrestricted right to use and exploit software. Suppliers should consider at least:

(a) the scope of the licence granted (including the length of the term, geographical limitations, maximum users etc), and

(b) the circumstances in which they may want to terminate the licence (for example breach of contract, insolvency or change of control of the licensee).

In a recent case, a supplier supplied websites built from the supplier's proprietary template. The supplier's standard terms reserved intellectual property rights and granted only a non-exclusive licence to its customers. One customer complained of copyright infringement because a competitor was operating a virtually identical website which came from the same supplier. The customer had no grounds for a complaint because it did not own the copyright or have an exclusive right to use it.

This was probably a case where the customer did not check or understand the meaning of the licence terms and shows that it is very important to consider what type of licence is right for the circumstances.
(vi) Limitation of liability

A limitation of liability is a ceiling on the amount of damages that can be claimed by one party for a breach of a contract or other failure by the other party. These clauses are important because they allow a supplier and its insurers to predict the maximum amount for which they will be liable if the contract goes wrong.

Under the Unfair Contract Terms Act courts can consider whether a limitation of liability is reasonable and, if not, you will not be able to rely on it.

A supplier wants limitations in the contract and he wants them to be as low as possible while still being reasonable.

In order to pinpoint a limitation of liability that is appropriate to a particular deal and that is likely to be reasonable, suppliers should consider issues such as:

(a) the level of the supplier's insurance coverage,

(b) the scope of the supplier's obligations,

(c) any agreed service credit/ liquidated damages, and

(d) the likely cost of a failure on the customer's business.

But remember that a court will consider all the circumstances when deciding if a limitation is reasonable.

In the important case of Watford Electronics v Sanderson. The claimant, Watford Electronics sold computer products. Watford bought a new software system from Sanderson in February 1993. The software did not perform well and problems continued until 1996 when Watford gave up, bought a new system from a different supplier and claimed £5.5 million pounds damages (including loss of profits).

Sanderson's limitation clauses limited its liability to the price paid for the system, (about £100,000) and excluded loss of profits.

The Court of Appeal decided that both the clause excluding loss of profits and the clause restricting liability to the price paid for the system were reasonable for the following main reasons:

(a) Watford knew of the limitation and had similar limitations in its own contracts.

(b) The parties negotiated the price and Watford secured price reductions.

(c) The parties were of equal bargaining power.

The case law on limitation of liability is always changing and it is always wise to seek a technology lawyer's advice on limitations that are likely to be reasonable in the particular circumstances.

We also have a free information sheet on excluding and limiting liability in business contracts - again just email me and I will send a copy.

(vii) Liquidated damages

An alternative to limitation of liability clauses are liquidated damages clauses. Under liquidated damages clauses, specified breaches of the contract will attract pre-agreed financial damages (e.g. if the system is down for more than 1 per cent of 1 year, we will pay you £x for each additional 1 per cent of downtime).

Apart from the difficulties involved in agreeing a formula for liquidated damages and then monitoring the supplier's performance against which any damages are payable, the damages clause must be a genuine estimate of the loss that will be caused by a failure or the damages clause will be deemed to be a penalty and automatically void.
Some customers tend to feel more comfortable loading all the risk onto the supplier, imposing harsh liquidated damages clauses and sitting back expecting the supplier to deliver in the belief that they can rely on the damages clause if it all goes wrong.

This is not necessarily the best approach for a successful contract. Firstly as I just mentioned penalties are not enforceable anyway. Secondly the individuals on the ground actually delivering the services are not always aware of liquidated damages clauses and so they do not necessarily incentivise the supplier. And thirdly damages are rarely a substitute for having a system that works.

(viii) Distance Selling

In contracts made at a distance between a technology supplier and a consumer, there must be a distance selling regulations clause in the contract.

Distance contracts include contracts made on the telephone or on a website.

Under the Distance Selling Regulations consumers have a right to cancel most contracts. The right will last for seven days unless the supplier does not comply with the Regulations in which case the right to cancel will last for three months.

(ix) Termination

The supplier will want to exit the contract in certain circumstances (e.g customer's insolvency or breach of the contract (e.g. non-payment)). The contract must be clear as to how and when a party can terminate.

Also think about what is required by both parties on termination. For example a terminating supplier may want to get back all its intellectual property and be paid immediately (rather than after the typical thirty days).

(x) Data protection

The Data Protection Act regulates how businesses can use personal data. Personal data is any information that can identify an individual (name, address, email address, financial details, photographs or CCTV images are all included). All businesses process personal data which commonly relates to customers, staff, suppliers and other business contacts.

Along with the majority of organisations, many technology companies have yet to fully realise the impact that the Data Protection Act has on all businesses. It is more than four years since the Act came in to force, and many legal experts are predicting that 2004 is the year in which the initial leniency shown by the Information Commissioner will end and enforcement action will begin against businesses that do not comply.

The Data Protection Act carries criminal liability and unlimited fines in some circumstances and should not be ignored.

There remains a common misconception among businesses that some are exempt from the Data Protection Act. There are no exemptions from the Act at all (there are exemptions from small parts of it such as going on the register) but not from complying with the Act. Even MI5 has to comply.

Taylor Walton supplies a data protection audit service which is free of charge in most cases, again email me if interested. But for the moment a couple of matters of relevance to technology suppliers:

(a) If a supplier is able to access any personal data held by the customer the Act requires that there is a written contract between the customer and the supplier requiring the supplier to maintain appropriate levels of security. One example of this situation might be where the supplier has access to the customer's client database for the purposes of supplying IT support or outsourced services.

(b) If any personal data is to be sent outside of the European Economic Area then this must be either with the consent of the individuals concerned, or to an EC approved territory or under EC approved contractual clauses.

Although the Act is quite complicated and a bit of a maze, putting compliance measures in place is not as much of a headache as most people think.

3. Conclusions

So those are some key issues which are often important in technology deals. It is not possible to consider in detail all important issues in a short article but here are a few key points to take away:

(i) Clarify the output required at the beginning (what does the customer want and what can be achieved - more tests and pilots up front may delay delivery but could prove to be time and money well spent).

(ii) Clearly allocate the risk under the contract to the party that is best able to manage it (and different risks may be best managed by different parties) and then importantly leave that party to manage the risk.

(iii) Make sure the contract is flexible enough to allow changes to be worked into it as the circumstances develop (if technology changes, a supplier may want to ask "This is what my technology can do, is it useful to you?" and as the business develops a customer may want to say "My business processes are changing, please adapt the system/ services so that it supports a different process").

(iv) If it is appropriate to the particular project, incorporate an end to end project plan into the contract listing both customer and supplier dependencies and have regular review meetings.

(v) Finally and most importantly you must have a good starting point for all deals (so your standard supply terms have to be robust). If you are starting from a good starting point then you should need less time, effort and cost to sort out each contract.

Businesses without good standard contractual documentation could face expensive legal problems and suffer commercial disadvantage which competitors may be avoiding.

Again email me if you have any concerns or feel that standard contracts need to be reviewed.

Taylor Walton supplies a comprehensive range of commercial legal services. If you would like to discuss the content of this article or any other commercial matter, please email Mike Pettit or Tim Cook or call Taylor Walton on 01582 731161.

© Taylor Walton 2004. All rights reserved.

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