by Stephanie Overby

IT Outsourcing: Landmark Ruling Against HP’s EDS Gives Customers New Power

Feb 10, 2010

A recent U.K. court finding against HP's EDS for failing to deliver on its sales pitch could radically change the dynamics of outsourcing everywhere.

In what could be an important decision for the IT outsourcing industry and its customers, a London court recently ruled that EDS (now part of Hewlett-Packard) must pay damages to a former outsourcing customer for failing to live up to its sales pitch.

British Sky Broadcasting (BskyB) had signed a £48 million outsourcing contract with EDS to build a customer service system in 2000, but terminated the deal early in 2002 after what it said was “woeful” performance by the IT service provider. BSkyB alleged deceit, negligent misrepresentation and breach of contract by EDS.

Although the total costs and damages will be determined at a later date, BskyB said it expects EDS will be liable to pay at least £200 million—more than four times the amount of the original contract.

“This size of claim for a fraudulent statement made prior to an IT contract being signed is unprecedented within the U.K.,” says Peter Brudenall, a partner in the London office of law firm Hunton & Williams.

The damages include the “cost of replacement services” several times the contract price, which is unusual, according to Dan Hildebrand, a partner in Mayer Brown’s litigation practice.

In fact, it’s rare that an outsourcing dispute makes it to court, let alone to a final decision. And given the result, many outsourcing experts expect this could have implications not just in the U.K. but industry-wide.

“Customers are often discouraged to take on their vendor in such a manner and settle for far lower compensation than they could otherwise get in court,” says Phil Fersht, an independent outsourcing analyst and author of the outsourcing blog Horses for Sources.

Vendors want to avoid the bad publicity of a trial, and the customers just want the problem to go away. Consequently, disputes are often arbitrated outside of the courts, which results in confidential settlements.

“This could set a precedent to encourage more customers to seek damages for business impact caused by poor IT delivery performance,” Fersht says.

“The basic lesson is the same on both sides of the pond,” says James Harvey, a partner in the Hunton & Williams outsourcing and privacy group in Atlanta. “Customers need to pay attention to what suppliers say so that they’re sure they get the full benefit of suppliers’ statements. And suppliers need to be somewhat more thoughtful with their pursuits so that they don’t overpromise, underperform and then get brought to task for it.”

Although the U.K. court ruling was decided largely on the basis of facts from one person’s statements as opposed to systematic failings of the outsourcer or outsourcing vendors as a whole, says Brudenall, dissatisfied outsourcing customers may go digging through notes from the pre-contract courtship phase of their relationships to see if arguments around fraud can be made.

“The letter of the contract will generally prevail under U.S. law,” explains Harvey, “unless a complaining party is able to prove that there was fraud in the inducement to sign the agreement or intentional misrepresentation or something of that nature that would cause a court to look beyond the contract itself.”

It’s likely only large or high-profile outsourcing customers might consider this kind of lawsuit, but Fersht says he’s already seeing several vendors trying to preventatively terminate unhappy—and unprofitable—relationships where delivery is not meeting expectations.

“It’s not always the vendor’s fault,” Fersht points out. “It’s often a combination of poor relationship management on both sides.”

The cost of establishing an outsourcing agreement could also go up as a result of customers engaging in more extensive due diligence on their providers’ pitch, notes Harvey. And, says Brad Peterson, a partner in Mayer Brown’s sourcing practice who helps companies contract with IT vendors, “it will be harder for customers to get vendors to accept risk.”

What’s unclear is whether this case is likely to influence vendors’ sales tactics. “The days of IT suppliers making grandiose claims about the abilities of the company or a particular piece of technology should be over,” says Brudenall. “If suppliers learn anything from this case, it is that courts—in the U.K. at least—will come down hard on any supplier found to have given misleading and fraudulent statements to a customer in order to win the business.”

Vendors already know the risks of putting “optimists” on commission, says Peterson, and have controls in place to manage that.

Still, “the pressure to win business is greater than ever,” says Fersht. Some providers may continue to promise the moon, and “just try harder not to mess up with clients in the future.” That could mean greater attention to SLAs in the negotiation process and increased investment in project management and client delivery expertise.

Diligent IT outsourcing customers should make sure their contracts capture as much of what is said during sales and negotiations as possible.

“Customers need to take the time and invest the energy to get the contract right and to document exactly what products and services they think they’re buying,” advises Harvey. “Without that, customers are left trying to prove that the supplier has engaged in fraud or misrepresentation, and that’s a difficult task from a legal perspective. It’s much better to get it right the first time and use the contracting process as a sort of due diligence period to really test and probe and capture what the suppliers are trying to sell.”