Large Stakes and Big Mistakes: A Case Summary of CIS General Insurance Limited v IBM United Kingdom Limited

  • May 06, 2021
  • Julia Sydorenko and Wendes Keung, WeirFoulds LLP

On February 19, 2021, the Technology and Construction Court in the United Kingdom (“Court”) released CIS General Insurance Limited v IBM United Kingdom Limited (“CISGIL v IBM”), in which the Court considers the failure of a high-value digital transformation project and the eventual termination of the project agreement. The 754 paragraph decision provides commentary on repudiatory breach, exclusion of liability for indirect damages, breach of warranty, and project delays, which provides a number of helpful points for consideration for technology lawyers. Large-scale IT cases are relatively rare, so this decision not only provides important lessons for drafting and negotiating technology contracts, but also unique insights into the potential pitfalls to be aware of in the implementation of large-scale digital transformation projects. For ease of reference, a chronology of events is included at the end of this article.

Facts

CIS General Insurance Limited (“CISGIL”), which was a wholly-owned subsidiary of the Co-operative Group Limited (the “Co-op Group”), is in the business of underwriting and distributing general insurance products. In 2014, following a re-organization of the Co-op Group, CISGIL decided to acquire a new IT solution for its business to replace the outdated and economically unsustainable IT infrastructure it shared with the Co-Op Group. On June 16, 2015, CISGIL entered into a contract with IBM United Kingdom Limited (“IBM”) for the supply of a new IT system for CISGIL’s insurance business, and the management of the system for a term of ten years. The contract comprised of a Master Services Agreement (the “MSA”), an Implementation Statement of Work (the “Implementation SOW”), and a Managed Service Statement of Work (the “Managed Service SOW”).

The value of the MSA was substantial. The cost of supply and implementation of the new system was £50.2 million. The cost of the management services to be provided over a period of ten years from the implementation of the system was estimated to be £125.6 million. In addition, CISGIL paid an initial £5.6 million to plan the implementation of the IT solution to meet CISGIL's requirements and to finalize the timeframe for delivery.

IBM engaged Innovation Group (“IG”) to supply software and services for the required insurance platform solution, which would leverage their proprietary software, “Insurer Suite”. The Insurer Suite was to be delivered using an agile approach and in two separate releases. The first release was scheduled to be delivered by the end of April 2016 (“Release 1”), and the second release was due by August 2016 (“Release 2”). The key requirement for IBM was to source and configure an “out of the box” general insurance solution to meet CISGIL’s requirements set out in the Implementation SOW, including some customization.

Delays occurred and the contractual dates for the go-live of Release 1 and Release 2 were not met. On March 24, 2017, IBM submitted an invoice for £2.9 million in respect of Application Gate 5, a milestone in the Implementation SOW (“AG5”). IBM’s position was that the AG5 invoice reflected payments due in respect of software licences and became payable in January 2017. CISGIL’s position was that payment was not due because AG5 had not been achieved and CISGIL had not authorized payment or issued a purchase order for the same. IBM served a notice of termination due to CISGIL’s failure to pay the AG5 invoice in July 2017. CISGIL considered IBM’s termination notice to be invalid and a repudiation of the MSA, which CISGIL accepted. In December 2017, CISGIL initiated legal proceedings against IBM for wasted expenditure and/or losses incurred as a result of IBM’s purported breaches. IBM counterclaimed for payment of the outstanding AG5 invoice.

Issues

The Court considered the following issues in CISGIL v IBM:

  1. Was IBM entitled to exercise its termination rights under the MSA because CISGIL failed to pay the AG5 invoice?
  2. Did IBM breach the representation and warranty in the MSA that required IBM to ascertain the risks associated with Insurer Suite?
  3. Did IBM breach its reporting obligations under the MSA by failing to report on the true state of the project?
  4. Did IBM breach the MSA by failing to meet the Release 1 and Release 2 milestones, and/or failing to report in respect of such delays? 
  5. What is the quantum of damages, if any, that CISGIL is entitled to?

Claim Summary

Claims

Damages

CISGIL Claim

IBM Response

Holding

Claim Amount

Awarded Damages

Wrongful Termination (Primary Claim) – CISGIL claimed wasted costs arising out of the alleged wrongful termination by IBM.

IBM was entitled to payment of the AG5 invoice, regardless of any failures to meet other milestones. CISGIL wrongfully failed to pay the invoice and was not entitled to rely on any right of set off because any such right was exercised too late. As a result, IBM was entitled to exercise its contractual right to terminate.

IBM was not entitled to exercise its termination rights under the MSA for CISGIL’s failure to pay the AG5 invoice. IBM’s purported termination amounted to repudiatory breach, which CISGIL accepted.

£128 million

No damages awarded for wrongful termination; excluded as they were indirect losses under limitation of liability clause.

IBM is entitled to set-off the sum of £2,889,600 for the AG5 invoice

Breach of Warranty (Alternative Claim) – IBM contractually warranted that it had taken all reasonable steps and satisfied itself as to all risk, contingencies, and circumstances as to its performance of the MSA. CISGIL claimed that such  warranty was untrue.

Insurer Suite was developed for an international market and did not need to be re-written or re-developed for UK insurers. The parties recognized that base development, customization, and configuration would be necessary for the software to meet CISGIL’s business requirements as set out in the MSA.

CISGIL’s claim for breach of warranty was dismissed.

£70.4 million

No damages awarded for breach of warranty.

Delay (Alternative Claim) – A material factor in the late delivery of the platform was that Insurer Suite had been developed for use in the United States but not the United Kingdom.

IBM was not liable for the delays to the project because they were caused by: (i) CISGIL’s delays in providing details of its requirements and other necessary information required to build Release 1; (ii) CISGIL’s failure to conduct user acceptance testing (“UAT”) of Release 1 in a timely and competent manner; and (iii) CISGIL’s delays in providing its requirements and other necessary information required to build Release 2.

IBM was in breach of the MSA for delays to certain milestones.

£128 million; alternatively, £36.1 million, are claimed on the basis that it would have  terminated the contract early if IBM had satisfied its reporting obligations.

£15,887,990

Failure to Report (Alternative Claim) – Costs of delay to the project caused by IBM and its failure to report accurately on progress.

IBM contends that it complied with its reporting obligations.

IBM was in breach of its reporting obligations in respect of the delays to the project.

£27.2 million

(included in £15,887,990)

Issue 1: Termination

The issue before the Court was whether IBM exercised a valid right of termination by reason of CISGIL’s failure to pay the AG5 invoice, or whether its purported termination amounted to repudiatory breach. CISGIL’s case was that the AG5 invoice was not payable because IBM failed to meet prior milestones, in particular, Release 1 and Release 2. Further, CISGIL claimed that the AG5 invoice was not due and payable because CISGIL did not approve AG5 and that the AG5 invoice was not properly prepared and submitted. Finally, CISGIL’s crucial argument rested on a claim that the AG5 invoice was under dispute, such that IBM did not have the right to terminate in July 2017. IBM’s response was that AG5 was not dependent on the achievement of any other milestone and not subject to approval by CISGIL. Further, the AG5 invoice was properly prepared and submitted, and was not disputed in time by CISGIL. 

In interpreting the MSA and SOWs, the Court found that the natural and ordinary meaning of the language in the documents led to the conclusion that the AG5 invoice was due and payable in January 2017. CISGIL did not have grounds to withhold approval of the AG5 invoice and the AG5 invoice was properly prepared and submitted for the following reasons: (i) no criteria was articulated for the completion of AG5 and that such completion was distinct from Release 1 and Release 2; (ii) unlike Release 1 and Release 2, AG5 was not subject to any formal acceptance procedures; (iii) AG5 had no direct predecessor milestone and was not dependent on completion of prior milestones; (iv) the MSA and SOWs did not address the basis on which AG5 would be considered to be completed; and (v) the only condition to the AG5 payment was timing, which indicated it would become due in January 2017, and as such, CISGIL was contractually obligated to approve the AG5 payment at that time and to issue a purchase order number for same.

The Court accepted IBM’s submission that CISGIL could not rely on the absence of approval or a purchase order number to withhold payment of the AG5 invoice where such approval and purchase order number was wrongfully withheld. CISGIL was not entitled to benefit from its own default in seeking to avoid payment by asserting the invalidity of the AG5 invoice based on the absence of such approval and purchase order. The Court similarly dismissed CISGIL’s complaints that the AG5 invoice was defective and/or not properly submitted in accordance with the requirements in the MSA because such complaints were not articulated at the time the invoice was considered and rejected by CISGIL.

The main question before the Court was whether CISGIL properly disputed the AG5 invoice and thereby had the right to withhold payment for same. This finding would ultimately determine whether IBM wrongfully terminated the MSA with CISGIL in July 2017.

The Court found that CISGIL properly disputed the invoice by rejecting it, and was therefore entitled to withhold payment of same, for the following reasons:

  • CISGIL’s rejection of the AG5 invoice because it was missing a purchase order number, and CISGIL’s indication that it would not pay the invoice on this basis, was within the contracted timelines and considered sufficient notification to place the AG5 invoice in dispute;
  • IBM had accepted the AG5 invoice was rejected, identified it as disputed, credited it in its internal accounting system, and added it to the table of disputed invoices;
  • CISGIL’s interpretation of the MSA and SOWs such that the AG5 invoice was not yet due, although ultimately wrong, was worthy of scrutiny and could not be considered unarguable, and thereby its dispute regarding the AG5 invoice was not so unreasonable that it amounted to bad faith; and
  • CISGIL was not contractually obligated to forewarn IBM of, or justify its decision to, withhold the purchase order for AG5, or to activate the dispute resolution procedure.

Provided the Court’s finding that CISGIL’s dispute of the AG5 invoice was valid, the Court decided that IBM was not entitled to exercise any right of termination under the MSA. Given this, IBM’s purported termination under the MSA amounted to repudiatory breach, which CISGIL was entitled to accept.

Issue 2: Breach of Warranty Claim

CISGIL had pleaded that IBM was in breach of the warranty to satisfy itself as to all risk, contingencies, and circumstances regarding performance under the MSA. CISGIL’s case was that IBM had not taken all reasonable steps to ascertain the risks associated with IG’s software and to determine if it was capable of providing the solution within the contractual or other reasonable timeframes.

Having reviewed the evidence in detail, the Court concluded that IBM did not breach the warranty. Insurer Suite did not require re-development or re-writing to meet CISGIL’s UK regulatory requirements beyond what was identified in the MSA, nor was Insurer Suite substantially re-written or redeveloped in a way that was not contemplated in the MSA. In particular, IBM had taken all reasonable steps to satisfy its obligations pursuant to the warranty by performing the following:

  • Due Diligence: The parties had engaged in a substantial amount of effort over a period of a year prior to the execution of the MSA on due diligence and phases of investigation and collaborative working to understand what was required and what would be supplied.
  • Fit-Gap Assessment: The parties carried out fit-gap exercises and analysis, including detailing a breakdown of the product, base development, customization, and configuration that would be supplied by IBM to meet CISGIL business requirements. CISGIL had signed off on the fit-gaps, and it was understood that not all of CISGIL’s requirements would be met by Insurer Suite without customization.
  • Specialist Support: Although IG’s ‘agile’ methodology proved to be a failure, it had been developed with specialist support—no fatal flaw was identified in the methodology or the organization of the work.
  • Scrutiny of Estimates and Risks: IBM had obtained an estimate for the time and effort required by IG to carry out the development and meet the requirements identified by the fit-gap assessments. IBM had also considered the financial and technical risks associated with same.

Issue 3: Reporting Claim on State of Insurer Suite

CISGIL’s case was that: (i) at the date of the MSA, Insurer Suite was not a UK-ready, commercial off-the-shelf product which could be configured to meet CISGIL’s requirements out-of-the-box because it required to be substantially re-written and/or re-developed; (ii) as IBM was responsible for the performance of its subcontractor under the MSA, it was therefore imputed with IG’s knowledge as to the matters regarding the Insurer Suite; (iii) IBM failed to report the true state of the project to CISGIL; and (iv) if IBM had satisfied its reporting obligations, CISGIL would have terminated the MSA in 2015 or by February 2016.

As discussed above under Issue 2, the Court found that the Insurer Suite did not require substantial re-writing and/or re-development to meet CISGIL’s UK regulatory or business requirements beyond what was set out in the MSA. Based on the evidence tendered by the parties, the Court found that by late 2015, IBM was not aware that Insurer Suite had been written for the US insurance market rather than the UK market, or that it had to be substantially re-written and/or redeveloped to meet CISGIL’s requirements. In any event, CISGIL would not have terminated the MSA in 2015 or by February 2016.

Furthermore, although the MSA imposed on IBM the responsibility for the performance of its contractual obligations by subcontractors, it did not, expressly or implicitly, impute to IBM knowledge on the part of its subcontractors. The Court determined that the reporting and management obligations set out in the MSA were limited to matters within IBM’s actual knowledge and did not extend to matters known only to IG.

Issue 4: Delays and Reporting Failures

CISGIL argued that IBM was responsible for the delay to the project with respect to certain Release 1 milestones and Release 2 milestones, and that IBM failed to satisfy its project management and reporting obligations. In response, IBM pleaded that pursuant to a term implied into the MSA, IBM would not be liable for late achievement or non-achievement of the milestones where such late or non-achievement was caused by CISGIL.

The Court reviewed the relevant case law for implying a term into a commercial contract. For a term to be implied, the following conditions (which may overlap) must be satisfied: (i) it must be reasonable and equitable; (ii) it must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it; (iii) it must be so obvious that ‘it goes without saying’; (iv) it must be capable of clear expression; and (v) it must not contradict any express term of the contract.

Applying the above test to the facts, the Court found that IBM had not established that an implied term exonerated it from liability for late achievement or non-achievement of the milestones. Even if such an implied term might be reasonable and equitable, the Court acknowledged that it is always open to the parties to allocate risk in a commercial contract. The MSA and the Implementation SOW set out a complete code for the dates by which IBM was obliged to achieve the milestone delivery dates. To imply the term argued by IBM would contradict the express requirements for notice of delay to be given as a pre-condition to any relief. As such, the Court held that there was no necessity to imply the term alleged by IBM.

On the evidence, the Court found that, in breach of the MSA and the Implementation SOW, IBM failed to meet the key milestones for Release 1 and Release 2 and failed to provide accurate reports regarding the delays during the project. The cause of the critical delay was primarily due to IG’s inadequate resources to perform the Release 1 customization and configuration work identified in the fit-gaps. Further, the configuration and customization work done by IG was of poor quality, resulting in many defects that IG was slow to resolve.

Issue 5: Quantum

Generally, the quantum of damages for breach of contract should reflect the value of the contractual bargain that the claimant has been deprived of as a result of the defendant’s breach. In a commercial contract, the value of such damages is usually measured by reference to the amount of money that the claimant would require to achieve the financial value of the expected contractual benefit, such as lost profits, the cost of reinstatement, or diminution in value (“the expectation basis”). Alternatively, a claimant may elect to claim damages by reference to expenditure incurred in reliance on the defendant’s promise, such as sums paid to the defendant or other wasted costs (“the reliance basis”). In this case, CISGIL’s primary claim was for wasted expenditure on the reliance basis, namely, the costs incurred in respect of the project in the sum of £128 million, resulting from IBM’s wrongful termination.

To determine whether CISGIL was entitled to the damages sought, the Court’s starting point was identifying the contractual benefit that was lost as a result of IBM’s repudiatory breach of contract. The loss of the bargain suffered by CISGIL comprised of the savings, revenues, and profits that would have been achieved had the IT solution been successfully implemented. The limitation of liability clause in the MSA specifically excluded any claim by either party for “loss of profit, revenue, savings (including anticipated savings) … (in all cases whether direct or indirect) …” Despite CISGIL framing its claim as one for “wasted expenditure”, the Court was of the view that this amounted to a claim for lost savings, revenues, and profits, which was specifically excluded by the limitation of liability clause in the MSA.  As such, CISGIL was not entitled to damages for IBM’s repudiatory breach of the contract.

CISGIL was, however, entitled to costs incurred as a result of IBM’s failure to meet the milestone dates, for the reasons set out under Issue 4. The cap for direct damages under the MSA was set at the greater of: (i) £15.7 million; and (ii) 125% of the total charges paid for the managed services in the twelve months preceding the first cause of action. CISGIL was entitled to recover £15,887,990, which fell within the cap, for additional costs incurred as a result of IBM’s breaches of contract.

Conclusion

This lengthy judgment provides important commentary for technology lawyers and technologists alike on due diligence, agile methodology, milestone delay, contract management, vendor and customer communication, and course correction. Although it is hard to say if there were any real winners in this case, the decision provides an abundant list of details to consider when drafting and negotiating large-scale technology agreements, and the pitfalls to be aware of when managing agile development projects. The substantial value of the digital transformation project, and the relative rarity of a large-scale IT case, make this a significant case with far-reaching consequences. Given what is at stake, an appeal of this decision is eagerly anticipated.

Chronology of Events

Date

Event

June 6, 2014

CISGIL issued a Request for Proposal in respect of a new IT solution for CISGIL. The stated objectives of the IT solution included delivery of a fully managed end-to-end new solution for CISGIL’s business, including core policy administration, billing, claims and enterprise systems, human resources, data warehouse, and relationship management.

July 4, 2014

IBM prepared an executive summary proposal in response to CISGIL’s Request for Proposal.

October 31, 2014

CISGIL and IBM agreed to terms of engagement for the due diligence process, which was undertaken between October and December 2014.

January 21, 2015

CISGIL and IBM entered into an Interim Services Agreement, which included a fit-gap analysis for the IT solution.

June 16, 2015

CISGIL and IBM entered into the MSA.

July 1, 2015

The first sprint for Release 1 took place (the duration of Release 1 was intended to be six sprints, each lasting three weeks).

July to December 2015

CISGIL and IBM encountered issues and delays with respect to Release 1 milestones.

December 2, 2016

CISGIL and IBM entered into an Amending Agreement, which set out updated milestone delivery dates.

End of January 2016

IBM failed to deliver the complete build of the Release 1 code by the end of January 2016, as required by the Amending Agreement.

Early of March 2016

The May 2016 go-live date for Release 1 was not met.

April 13, 2016

CISGIL halted UAT.

April 19, 2016

Executive representatives of CISGIL and IBM met to discuss the revised dates for the Release 1 milestone. This meeting was a turning point in the relationship. From this time onwards, there was a complete breakdown of trust between the parties.

May 6, 2016

CISGIL suspended UAT.

May 12, 2016

CISGIL sent a letter to IBM alleging that IBM was in breach of the MSA for missing the milestones for Release 1 and Release 2.

May 24, 2016

CISGIL served a formal notice of breach on IBM.

March 25, 2017

IBM submitted to CISGIL its invoice for AG5.

March 27, 2017

The AG5 invoice was rejected by CISGIL and payment was not made.

June 22, 2017

IBM served a final notice to CISGIL with respect to the AG5 invoice.

July 27, 2017

IBM served a termination notice to CISGIL, purporting to exercise its right to terminate under the MSA.

July 28, 2017

CISGIL informed IBM that CISGIL considered IBM’s termination notice to be invalid and a repudiation of the MSA, which repudiation was accepted by CISGIL.

December 18, 2017

CISGIL initiated legal proceedings against IBM.

Any article or other information or content expressed or made available in this Section is that of the respective author(s) and not of the OBA.