IT projects – Be wary of overpromising

A common cause of many disputes in IT projects is where the commercial expectations of the parties have become fundamentally misaligned. Businesses which are purchasing a new IT system or application may already harbour expectations of what they are hoping to receive, for example in respect of functionality, cost and timescales. However, where such expectations are reinforced, or even emboldened, by a supplier who over-promises on delivery in an effort to secure a sale, it can simply store up problems for later.

This mismatch in expectations can lead to a number of issues for an IT project in the delivery phase, such as increasing delays, missed contractual milestones, progressive “scope creep” and budget overruns. As such issues continue to arise, it creates an inevitable tension between:

• on the one hand, a customer who is becoming increasingly frustrated by an IT contractor that seems unable to deliver the functionality that was promised on time and within budget; and

• on the other hand, an IT contractor that is becoming increasingly frustrated by a customer who has unrealistic expectations and who keeps changing its mind about exactly what it wants.

All too often this tension can spill over into full-blown disputes, leaving the customer feeling like it hasn’t got what it paid for; and the IT contractor feeling like it has a customer who is impossible to work with.

Types of claim

When a distressed IT project ends up in a typical dispute scenario like this, the most common type of allegation which emerges is one of breach of contract. Depending on the scenario at hand and the precise terms of the contract, it might be the customer complaining that the IT contractor is in breach, or vice versa. Sometimes both parties throw breach of contract allegations at one another.

Allegations of misrepresentation may also be made, which is where one party alleges that the other party has made certain false statements which were relied upon when entering into the contract. Whether or not IT contractors will face liability for misrepresentation often depends on exactly what was said before the contract was entered into, as well as how successfully the contract excludes liability for such pre-contract statements.

The risks of overpromising

Another key tension that can arise in an IT project is one between a supplier’s sales team, who are inevitably motivated to secure new work and get sales over the line, and the delivery team, whose job it is to deliver whatever the supplier has committed to. In many organisations, these two teams will liaise closely with each other to ensure that projects are properly scoped and realistically priced. However, this is unfortunately not always the case.

A prime example of how badly things can go was the well-known case of BskyB v EDS, which is several years old now (it was decided in 2010), but still serves as a stark warning to IT contractors who might be tempted to over-promise to prospective customers in an effort to secure a sale. That case concerned an IT project that EDS (now part of Hewlett Packard) was working on to build and implement a new customer relationship management system for Sky. When the project ran into difficulties, Sky claimed that EDS had intentionally misled it during the tender phase in terms of the timescales for implementation. The court ultimately agreed with that submission and EDS was held to have fraudulently misrepresented the position with respect to timescales, with the key salesman being found to have knowingly proposed timescales that he thought Sky wanted to hear, but which he knew could not realistically be met. This was a crucial decision for EDS’ exposure on the project, since it meant that it could no longer rely on the limitation of liability clauses in the contract, exposing it to hundreds of millions of pounds of alleged loss.

It is fair to say that this finding of fraud sent shockwaves through the IT community and sent a clear message to IT suppliers that if they recklessly mislead customers during the tender phase, they do so at their peril.

Personal liability for directors

There has been an increased focus on directors’ duties generally, including within the tech sector. Directors will need to be alert to their director duties and to understand when their duties to creditors are engaged. In an IT dispute context, where the costs of the IT project might be spiralling and creating increased financial pressure, such considerations might apply equally to the directors of the purchasing company as well as the IT supplier.

Generally, limited companies protect personal assets from business debts. However, certain circumstances can give rise to direct personal liability for directors. It is imperative for directors to take stock of their position as soon as a dispute arises.

A director’s decision making will be scrutinised in the context of a dispute; for example, if the director exercised proper judgment at a critical moment or if they had acted with adequate care. While directors’ duties are owed to the company, they can be enforced by shareholders by way of a derivative action on behalf of the company.

Counterparties will usually require a director to provide a personal guarantee to secure business financing or significant IT contracts. A director will need to understand the full extent of their exposure before signing a personal guarantee. If the company fails to meet its obligations, the director becomes personally liable for the shortfall. This applies regardless of whether the company is solvent and how the dispute arose.

In circumstances where a company or IT contractor is under financial pressure, it is important for directors to take proper legal advice about their obligations to creditors. A director will likely face personal claims for compensation when certain duties owed to the company are breached particularly if the company is bordering on insolvency. A director will need to be mindful of making decisions where the inevitable outcome is to result in insolvent administration or liquidation.

Most directors assume limited liability protects them from company tax debts also. However, HMRC has specific powers that can pierce that protection by virtue of a Personal Liability Notice (PLN), which is a statutory notice issued by HMRC under section 121C of the Social Security Administration Act 1992. Its effect is to transfer the company’s specific unpaid company tax liabilities onto a director personally, regardless of the company’s insolvency.

The availability of adequate insurance to cover such risks is of equal importance. D&O insurance exists to protect directors when management decisions are questioned, as can often be the case in the wake of an escalating IT project dispute. However, insurance will not typically serve as a full and operative risk transfer solution where the claim arises from fraudulent conduct by an “insured person”. It follows that, subject to the individual policy wording in play and the causal connection imported by the policy terms, questions will often arise in situations such as those considered by the Court in EDS as to whether (a) the knowledge and involvement in the fraud (e.g. fraudulent misrepresentation) can be attributed to a person named in the policy as an “insured person”: this is usually defined to include directors, but in some policies it extends to employees, (b) the fraud has been proven and determined by a court or arbitrator at final hearing. This last consideration is likely to pique the interest of insurers and underwriters since, where a final adjudication or judgment is required to trigger the operation of any fraud exclusion, significant costs in defending the action may need to be incurred before there are grounds on which to decline a claim.

How can IT project disputes be avoided?

Whilst there can be no guarantees that such disputes won’t arise, and there is no “one-size fits” all approach that can be adopted, the following points may nonetheless help to minimise the scope for fall-out:

• IT contractors should ensure that statements made during the pre-contract phase are either properly supportable or suitably caveated.

• Communication is key. Technical personnel who will actually be running the project should be speaking to the sales personnel who are trying to win the contract. Operating in silos is invariably a recipe for disaster.

• Suitable effort should go into agreeing and signing-off on a detailed scope of work at the outset of the project. Doing so will force the customer to be clear about its detailed requirements from inception.

• Any deviations from the agreed scope (which will likely impact on cost and timescale) should be carefully logged and dealt with in accordance with any agreed contract change mechanism.

• The parties should maintain a good working knowledge of the contract during the life of the project. It is often too late to start looking at the contract only once a dispute arises.

• Make use of any agreed dispute resolution mechanisms in the contract. They can often be helpful in resolving disputes before they escalate.

Adopting such practices should avoid things veering off course in the first place or help to get them back on track if they do. However, if things really have gone past the point of no return, consider matters very carefully before seeking to terminate the contract. Parties often rush to consider termination when it really should be a step of last resort. Termination without sufficient grounds to do so will quickly lead to dispute. If you are nonetheless approaching this particular crossroads, it will be sensible to take specialist legal advice without delay.