Tag Archives: IBM

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Determining the “Materiality” of a Breach of Contract

It is likely that your business contract contains a provision that grants the customer the ability to terminate the agreement without payment of penalties in the event of a “material breach.” Unfortunately, many contracts fail to identify what constitutes a material breach. Without this clarification in the contract, the determination must typically be made by a judge when a dispute arises.

What does the court consider “material breach?” There is no standard test or bright-line rule to guide the court in making this decision, so you never want it to get that far. It is far better to protect both parties’ interests through careful negotiations and planning when drafting the contract. Below are a few considerations to include in a contract to help protect your company in the event of a material breach:

  • Set forth the exact performance-based termination rights. For example, the right to terminate the contract may be triggered if a service provider fails to meet a specified service level for three consecutive months. The more specific you can be in defining what constitutes a material breach, the better.
  • Define the damages available when a material breach occurs. If liquidated damages are used, remember that they will only provide an incentive to perform if they are set at levels equal to the value and cost of the services. In other words, make sure it is not cheaper to pay the liquidated damages than it is to deliver or perform. You want the remedies available to motivate performance, not provide a cheaper way to get out of the contractual obligations.
  • Reserve the right of election. You should also reserve the right to elect a remedy other than monetary relief if a breach occurs. This allows you to prevent the service provider from curing nonperformance by paying the liquidated damages. Examples of non-monetary remedies include the right to terminate the contract, injunctive relief and specific performance.
  • Conduct the relationship consistent with the contract terms. It is important to enforce or preserve your rights under the agreement. If you allow an exception for nonperformance, you must explicitly affirm your right to relief while simultaneously disclaiming that right for the specific circumstance. In other words, you want to provide written notice to your supplier that while you are permitting an exception in this one situation, you are not giving up your rights to enforce on time performance in the future. It is difficult to rely on the contractual breaches as the basis for contract termination if you have a history of turning a blind eye.

To learn more about how to effectively draft contracts or how we can assist you with other business-related matters, contact Leslie S. Marell today.

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State of Indiana v. IBM: Test for Determining the Materiality of a Breach of Contract

There is not a significant amount of case law on the topic of how to determine whether a party’s breach of a contract rises to the level of a “material breach.” However, an Indiana court recently provided some direction with its decision in State of Indiana v. IBM.

Facts of the case

The State of Indiana entered into a 10-year, $1.3 billion outsourcing contract with IBM. The contract provided that IBM would overhaul and update the state’s welfare system, including providing the ability for residents of Indiana to apply for welfare benefits online or by calling a call center. However, once the new system was implemented, it caused an increase in error rates and slowed the rate of eligibility determinations. The State of Indiana terminated the contract, claiming that IBM had materially breached the timing and quality requirements under the agreement.

Court decision

The State sued IBM for $1.3 billion for breach of contract and IBM filed a counterclaim to recover the value of the equipment left with the state under the terms of the contract. The trial court determined that both parties were at fault and that neither should prevail. The court used portions of the test set forth in Williston on Contracts in ruling that the evidence presented by the State did not prove a material breach by IBM. The two factors the court focused on were:

  • the extent to which the injured party will be deprived of the benefit which it reasonably expected
  • the likelihood that the party failing to perform or to offer to perform will cure his failure

The court concluded that because the state obtained an improved welfare system from IBM, it was not denied the benefits it reasonably expected. The court also found that just prior to the termination of the contract, IBM was in the process of curing the timeliness problems. Finally, the court discussed whether the breach went “to the heart of the contract” and found that because IBM substantially performed, there wasnt a material breach.

The Aftermath

The court’s decision is troublesome because IBM avoided the material breach claim by only meeting between 50% and 80% of the required service levels. The court did not give much credence to serious breaches in the service levels and instead focused on the disclaimed warranty of “uninterrupted or error-free operation” when analyzing the performance issues.

If you are negotiating an outsourcing agreement, it is important to negotiate and clearly identify the performance standards in the contract. For tips on how to accomplish this in your contracts, please read our next blog titled “Defining ‘Material Breach’ in Your Contract.”

To learn more about how to draft an effective contract or how we can assist you with other business-related matters, contact Leslie S. Marell today.

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IBM’s Legal Department: A New Approach with Contracts

Assistant general counsel at IBM, Neil Abrams, believes that he can better serve clients and customers by simplifying matters. With this strategy in mind, Abrams has led a team in reducing complex and lengthy contracts for cloud services to a straightforward, two-page document.

Abrams explained to CorpCounsel.com that the contracts for a large number of cloud services were causing frustrating obstacles for customers. The contracts would be sent to the customer’s attorney who would begin negotiating the wording and the progress would come to a frustrating standstill.

Abrams’ team took a couple of months to reduce the crucial points of the contract into a two-page document. They even translated it into more than 20 languages, using concise and plain wording. The team did not use cross-referencing, hyperlinking or including other documents into the contract by reference.

Additionally, while many businesses also require a separate contract that outlines what actions the company is going to take or the “professional services” to be provided, the new IBM contract includes services. Abrams’ team even included intellectual property indemnification in the contract, which many cloud providers do not include.

The response to the new, shorter contract has been positive. It is less time-consuming for the customers and the attorneys are able to accomplish any necessary negotiations quicker. In fact, IBM has even been recognized as a finalist for the 2014 Innovation Award for Operational Improvement for “boldly and rapidly transforming its cloud computing contract process.”

As far as Abrams, his work on the cloud services contract has moved him from head attorney for software to serving as an assistant general counsel tasked with looking for ways to improve IBM’s overall client experience, including the simplification of more contracts. In fact, Abrams has already released a four-page contract that covers all of IBM’s products and formerly averaged approximately 30 pages.

Many large companies have template contracts that their internal clients use and over time they get longer and longer. As a result, the contracting process is taking longer. This can take a significant toll on both the buyer and the seller. As IBM is proving, simplifying and shortening contracts (with a focus on making them easier for internal clients to understand) can improve the process for all parties involved.

I have always been an advocate of making contracts clear and concise. I am encouraged by IBM’s advancement in this direction and it is my hope that many other large companies will follow in IBM’s path. It may be a challenge, but it will be worth it when the parties realize they truly understand what their contracts say and disputes are less likely to occur, which save everyone time and money.

To learn more about simplifying your contracts or how we can assist you with other business-related matters, contact Leslie S. Marell today.