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Monday, February 11, 2013

CA fires contractor, providing a helpful breach of K scenario

The LA Times reports that the state of California has terminated its contract with SAP Public Services, a contractor that was supposed to fix the state's outdated computer network system that handles paychecks and medical benefits for 240,000 state employees. 

While both SAP and California are unhappy about the state of events, I have just covered breach, substantial performance, conditions and damages in my Contracts course and was delighted to find a real life scenario to illustrate the relevance of the material we just covered. 

So what triggered CA's termination?  SAP was hired three years ago but when its program was tested, it made errors at "more than 100 times" the rate of the old system. 

Was failing this test a breach?  If so, was it a minor or material breach?  It seems it would depend on what was in the contract. As contracts profs know, the first place to look in a contract dispute is the contract itself.  The are terms in the contract that will be relevant in evaluating whether there was a breach or the applicable measure of damages.  For example, there may be performance targets (i.e. conditions) that SAP had to meet which weren't met.  Those conditions would be relevant in determining each party's obligations (would the contract terminate upon failure to meet the condition, for example?)  There's also likely to be a provision dealing with whether SAP gets paid per deliverable or target met or per person/hour or time spent on a project. If this was a scheduled deliverable, then the facts tend toward finding a breach (or, if the contract language indicates, it could be a condition that was just never met).  If it was a test done in the course of moving the project toward completion, CA may have jumped the gun.  A material breach would allow CA to then terminate its obligation.  If not a material breach, CA should have sought adequate assurance of performance and could itself be in breach by terminating the contract.

 Facts matter, as I repeat like a broken record to my students (I guess I should update my reference for the iPod generation) - so it matters what it means to say that SAP failed the test.  The LA Times reports that:

    "During a trial run involving 1,300 employees....some paychecks went to the wrong person for the wrong amoung.  The system canceled some medical coverage and sent child-support payments to the wrong beneficiaries."

Furthermore, because the system sent money to retirement accounts "incorrectly,"' the state had to pay $50,000 in penalties.

Given the late stage of the project, if not a material breach itself, the failed trial seems to at least give rise to a reasonable belief that SAP would breach.  What did CA do then?  Did it immediately terminate or seek explanations/reassurance? 

 Another issue is what damages measure is applicable?  CA paid SAP $50million dollars but it had incurred much more trying to get the system up and running.  It wasn't clear to me whether the $50million dollar amount was the amount paid up to that point, or the total due to SAP.  In class, the cases we study regarding breach of contract to provide services typically involve some type of construction contract.  The standard measure then would be the difference between the cost of completion and the contract price.  But in a situation like this, the cost of completion is a bit funny given the various factors involved - and the period of time it would take to implement a new project (SAP took the project over from a prior contractor).  Furthermore, the purpose of the new system wasn't so CA could make money (no loss profit measure applicable here).  Given that, the standard expectation measure likely would not be appropriate and a reliance (or restitution) measure makes more sense.  Not surprisingly, CA is seeking recovery of the $50million dollars paid. 

What about SAP? Will it claim that it substantially performed?  I don't think it can with a straight face, but again, I am only basing my conclusion upon the facts contained in the newspaper article.  Will SAP seek restitution for the reasonable value of its services to CA?  It very well may, (and any students reading this, should raise it on an exam...) since it has spent three years on this project.  Based upon the information in the article, it doesn't sound as though CA received any benefit from the services rendered.  If SAP is determined to be the breaching party, it may not get awarded anything. The real world problem for SAP is that trying to hang on to money for delivering a system that doesn't work might hurt its reputation even more.  And it doesn't help that the other party is a state entity - meaning lots of future potential business at stake.  (The LA times noted that SAP projects with other CA entities are not going so well, either).

As is true for other contracts profs, I spend a lot time trying to situate doctrine into a problem solving (or minimizing) scenario since this is how most lawyers deal with contract law.  For example, prior to cancelling the contract, the attorneys for the state of CA most likely sat down and discussed its available options under both the contract and contract law.  SAP, too, likely reviewed (or is reviewing) its options under the contract and contract law.  My guess is that the contract terms probably permit CA to cancel under these circumstances, although a spokesperson for SAP stated that it believed it had "satisfied all contractual obligations in this project."

I'm sure I missed a few things in my quick analysis of ths situation, so feel free to note any other issues in the comments.

[Nancy Kim]

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