Getting to yes, but at what cost?

Case involving EDS has relevance for NZ

The global financial crisis has exposed many instances of reckless deal-making leading to spectacular losses.

Such problems are not confined to the world of high finance. A recently decided (but long-running) UK case, BSkyB v EDS, demonstrates how one employee’s reckless determination to win an IT contract contributed to massive liability for his employer, and raises the question: how can a company protect against an employee’s reckless representations?

The BSkyB case

In 2000, BSkyB issued a tender for a CRM system. A fast implementation was one of its requirements.

EDS was one of several companies that responded. Joe Galloway, a then-senior manager at EDS, led his company’s bid for the lucrative contract. Galloway represented to BSkyB that the system could go live within nine months and be completed within 18 months. BSkyB relied on that representation, among others, and awarded EDS the tender for a price tag of some £54 million.

The parties entered into a formal contract. The contract included the usual provision that pre-contractual representations did not form part of the contract. It also included a clause purporting to cap EDS’ maximum liability at £30 million.

Unfortunately, the project suffered a series of setbacks and delays. The promised timetable turned out to be seriously underestimated. After two years BSkyB decided to cancel the contract and complete the project itself — which it did for a reported £265 million — and sued EDS for misrepresentation and other claims. The amounts claimed were extraordinary: BSkyB estimated its damages at more than £700 million.

At the subsequent court hearing, a key issue was Galloway’s confident time assessment during the tendering process. BSkyB had relied on that assessment to award EDS the contract. However, the judge found that Galloway had not performed a proper assessment of how long the project would take. Instead, the judge said he had simply “proffered timescales which he thought were those which Sky desired, without having a reasonable basis for doing so”.

In other words, Galloway told the customer what it wanted to hear, in order to win the contract.

As a result, the judge found EDS liable not for “negligent misrepresentation”, such as if EDS had carried out an assessment and made an honest underestimation, but for “fraudulent misrepresentation”.

This distinction had a profound effect on EDS’s liability. The judge accepted that had the inaccurate time assessment merely been a case of simple negligence, the contract’s £30 million liability cap would have applied (which, given the size of the claim, would have been a good outcome for EDS). But in the case of a fraudulent misrepresentation, such as the time estimate, the liability cap would not protect EDS. It was ordered to pay “preliminary” damages of £200 million, with the full liability of up to £700 million yet to be determined. EDS has since sought permission to appeal.

Grounds for misrepresentation

An important finding in the case was that Galloway had not simply misrepresented the timescale of the project, but had misrepresented that EDS had a proper basis for the timescale put forward.

Underestimating time is all too common in IT projects — something that the judge acknowledged — and certain steps, including contractual disclaimers and project control processes, can be effective to mitigate a supplier’s liability for such mistakes. With such measures in place, had EDS performed a reasonable analysis and simply got it wrong, it would likely have been able to limit its liability.

However, in this case, the judge found an implied representation by EDS that a proper analysis had occurred, when no such analysis had taken place.

In court, EDS denied that the 18-month timeframe was a representation at all, but was instead “one step in an on-going process of project planning”. Certainly, the response to the tender was couched in terms to allow some flexibility, for example: “the high level plan will be refined after further analysis of the current situation and business requirements”. However, the judge rejected these claims in favour of his clear finding that a misrepresentation had occurred (which is to say that an assessment had been performed). That misrepresentation was not remedied by the later addition of words adding flexibility to the final timeframe.

Nor was it remedied by the contract’s purported disclaimer of pre-contractual representations.

Deceitful dealings in New Zealand

In New Zealand, several laws are relevant to allegations of deceit or misrepresentation in trade, the most significant of which is the Fair Trading Act 1986. The key part of this Act states that “no person shall, in trade, engage in conduct that is misleading or deceptive or is likely to mislead or deceive.” The Act cannot be excluded by contract, and applies to virtually all local commercial dealing.

The basic implications of the Act are clear and well-understood. A further implication, illustrated by the above case, is that there should be a proper foundation for every representation made. Where something has simply been estimated without a robust analysis, it should be clearly identified as such. It is also important to note that under the Fair Trading Act, it is not just words or statements that can mislead. Liability can result if a party conducts itself in some way that causes the other party to be misled.

BSkyB v EDS provides a useful example, applicable in New Zealand, of a vendor impliedly misrepresenting that there was a proper foundation for making a statement in a pre-contractual situation. The message is that such conduct (making a representation without foundation) may not simply be “negligent” or an oversight, but may be found to be deceitful.

While a party can still incur liability under the Fair Trading Act even though they had no intention to mislead or deceive, a finding that a party actually intended to deceive will likely be decisive. A finding of deception is also relevant to the amount of liability that may result.

If the case had occurred in New Zealand, it is almost certain that on the same findings the conduct would have breached the Fair Trading Act, resulting in a significant award of damages above the contractual liability cap.

Controlling the human factor

The case is notable for the extreme quantum of liability being imposed largely in relation to one individual’s conduct. Seen in that light, it raises the question: how can a company protect against an employee’s reckless representations in a pre-contractual situation? Are there any practical steps — besides having good recruitment processes to keep out bad apples — that a company can take to prevent such liability?

While senior personnel who act in a reckless, incompetent or dishonest manner will always have the capacity to incur liability, steps include:

Better contracting: In the contract, EDS had introduced flexibility and made it clear that the timeframe would be refined through out the project. However, it did not deal with the prior, underlying misrepresentation that it had a proper basis for putting forward the initial timeframe, which the customer had relied on. If the contract had set forth some actual basis for estimating the timeframe (whatever it may have been), EDS may have been able to defend the claim of deceit.

Documenting representations: Key representations should be documented, reasonable and well founded. This may be difficult in complex pre-sale situations, but this case highlights the importance of controlling that process. In many cases it is sensible that key representations be written into the contract.

While it is not possible to contract out of the Fair Trading Act, some risk can be mitigated by recording in the contract exactly which representations each party has relied on.

Similarly, if during the contracting phase it emerges that certain representations made during the tendering phase are questionable, the parties could record that they no longer rely on those specific original representations.

However, such provisions will require very precise drafting to be effective in preventing liability under the Fair Trading Act — a blanket exclusion of pre-contractual representations will not typically suffice, as seen in this case.

Internal sign-offs: The BSkyB case is a classic example where additional internal control could have prevented the liability. Galloway was effectively able to sign-off on his own work. While he was in a senior, trusted position, it was (for example) still open to the Board to require an internal pre-tender review of key aspects of the bid. For a project of this scale and complexity, it was certainly justified.

This article provides general information and does not constitute advice. Professional advice should be sought on specific matters.

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