Recent developments in outsourcing
A guide to the latest considerations
18 July 2019
Doctrine of penalties
The recent Supreme Court decision in Cavendish Square Holding BV v. Talal El Makdessi confirms that the long-established doctrine of penalties remains highly relevant.
Under the traditional approach to the doctrine, a contractual provision that a pre-determined sum is payable on breach of contract will only be enforceable to the extent that the sum represents liquidated damages. In other words, the provision must constitute a "genuine pre-estimate of loss" and not an arbitrary or unreasonable amount designed to deter a party from, or penalise them for, breaching the agreement in question.
Following the judgement in Cavendish v. Makdessi, while the law of penalties still stands, we will now see a shift in focus to a new interpretation of the doctrine that places greater emphasis on proportionality and the "legitimate interests" of the parties.
Given the nuances and uncertainty introduced by Cavendish v. Makessi, businesses are well advised to ensure their contractual toolkits will stand up when scrutinised, not least in the context of outsourcing. While a business may consider its standard service credits mechanism as a clear-cut liquidated damages provision, this often comes down to a question of drafting. For outsourcing contracts, this decision has clear implications for service levels / credits, termination for convenience and other exit payments, as well as payments due on account of late delivery of committed transformation projects.
As devastating data security breaches continue to make the headlines, cybersecurity is becoming an increasingly important board level risk – especially in light of the new domestic and EU-level legislative regimes due to be introduced in 2016.
As well as mitigating exposure by developing appropriate technological and infrastructual safegaurds, our experience suggests that businesses are also eager to ensure they are adequately covered from a legal perspective.
Set against this backdrop, outsourcing services to a third party provider may sound, at first, like it would complicate compliance initiatives and increase the possibility of a data breach or other cyber attack. However, this is not necessarily the case. By leveraging the right legal framework, an outsourced servicing arrangement can in fact be designed to accommodate greater legal protection than an in-house set-up. Expect cyber indemnities, compliance warranties and stand-alone liability caps to form key points for negotiation in future.
The judgements in Wood v. Sureterm Direct Limited and Arnold v. Britton are further warnings of the court's reluctance to use commercial common sense to rewrite bad drafting. In Wood vs Sureterm Direct Limited, which concerned an indemnity provision, the court stressed that its function was not to relieve a party from the consequences of imprudence or poor advice.
Of course, every case involving contractual interpretation is fact specific. However, these decisions serve as a timely reminder that although the court will employ commercial common sense as an aid to construction, it will not in doing so depart from the actual language used in the contract. As ever, businesses entering into any outsourcing arrangement must ensure that the associated contracts leave no room for ambiguity.
Meanwhile, the decision in Portsmouth City Council v. Ensign Highways Limited, offers parties to outsourcing arrangements insight into the court's willingness to recongise implied terms, in this case a duty of good faith in relation to the award of service points under a long-term private finance initiative contract. The court ruled that while the contract in question did contain a limited implied term to act – when awarding service points – both honestly and on proper grounds and not in a manner that was arbitrary, irrational or capricious, there was no wider overriding duty to act in good faith.