contracts & liability

8/13/2019 Contracts & Liability

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Chapter 2

Software Contracts and

Liability

Information Systems p. 26/149


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Introduction

Well now have a look at an area youre likely toencounter in some way or another when working in IT

Contracts in the IT industryWe give a brief overview of contractual arrangements inthe IT sector

Also sketching implications that the different contracttypes have

Have a brief look at liability for defective software



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What is a Contract?

A contract is simply an agreement between two or morepersons

Can be enforced in a court of lawParties involved may be legal persons or naturalpersons

Legal person: legal entity that has the capacity toact, can acquire rights and create obligations(separate from its members)

No specific form: in England and Wales a contract

need not be written down



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What is a Contract? (2)

Essential points of a contract

All the parties must intend to make a contract

All parties are legally competent (i.e. old enough, ofsufficiently sound mind)

There must be a consideration: each partyreceiving/providing something

Contract law is largely based on common law

However, here we focus less on law but more on typical

content of contracts



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Types of Contracts in IT

Well be looking at

Development of tailor-made (bespoke) systems

Fixed price contractsTime and material

Consultancy and contract hire

OutsourcingLicense Agreements



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Fixed Price Contracts

Usually contains the following three parts

Short agreement: specifies parties, excludes

anything written or said from before the contractStandard terms and conditions: normally thoseunder which supplier does business

Set of schedules or annexes specifying

What is to be supplied and whenWhat payments are to be made and whenetc.



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What is to be Produced

Usually standard terms refer to annex which in turnrefers to requirements specification document

Ideally, the requirements specification iscomplete

consistent

accurateIn the real world very difficult to achieve

Often different versions of requirements are floating

around, correct one needs to be referenced incontract

Well come back to handling change in a moment



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What is to be Delivered

This is usually not simply handing over somefiles/documents containing programs

Contract has to state explicitly what changes hands,this can include

Source code

Command files and scripts for building executablesand deploying them

Documentation of the design and the code

Manuals for reference, training, operations

Maintenance tools

User training

Training of clients maintenance staff

Test data and results



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Ownership of Rights

Usually straightforward for tangible assets such ashardware, documents, data storage media

Legal rights are passed from supplier to clientMuch more difficult for intangible assets such asintellectual property rights

This is an important topic of its own, well discuss itin a separate chapter

Important here: contract should state precisely whoowns which rights



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Confidentiality

Very hard to avoid that supplier and client will acquireconfidential information during development process

Supplier may learn about internal processes of clientClient may find out details about specificdevelopment methods used by supplier

Usually both parties agree in the contract to maintainconfidentiality about these matters



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Payment Terms

Normally, standard terms and conditions specifypayment conditions

E.g. payment within 30 days of invoice, if payment isdelayed, supplier may terminate contract or chargesurcharge (e.g. base lending rate + 2%)

For long-running projects it is more realistic to have apayment in stages, for example

Initial payment of 15% (due on signing the contract)

Further staged payments totaling 50% on reachingcertain milestones

25% on acceptance

10% at end of warranty period



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Payment Terms (2)

Reasons for staged payments

Protects supplier from certain financial risks (e.g.

insolvency of client)Reduces cash flow difficulties on supplier side (staffhave to be paid)

Usually involves some negotiationSupplier prefers staged payments corresponding tocalendar dates (allows better planning)

Client favors tying them to project milestones(doesnt want to pay for unfinished work)



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Delays

Software development projects are notorious for beingdelayed and late

Normal mechanism for delays on supplier side arepenalty clauses

Penalty clauses usually reduce the sum payable to thesupplier by a specified amount per agreed time span

E.g. for a contract value of 1,000,000 penalty mightbe 5000 per week up to a maximum of 100,000



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Delays (2)

As delays in development projects are a well-knownfact, one would expect hefty fines

However, not that common for fixed price contracts

Delays already eat into profit margin of supplier, sothere is already an incentive to finish on time

As a consequence suppliers will be reluctant toaccept harsh penalty clauses

If penalty clauses are included, this usually drives upthe bid price

If software is seriously late and penalties approachtheir maximum, the incentive to finish drops

Supplier will have likely maxed out (staged)

payments they will get



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Delays (3)

Delays can also be caused by the client

Failing to provide required information on time

Change requests that result in extra workContract should provide clauses for calculating costsand extra payments

Payments for delays and variations to originalrequirements often lead to disputes (and even legalaction)

This is not restricted to IT sector, constructionindustry seems to be notorious

Sometimes used as a mechanism to increase profitmargin after over-competitive bidding



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Clients Obligations

Due to the hassles this can cause, it makes sense tospecify the obligations of a client in the contract

These can include (but are not limited to)

Provide documentation

on relevant activities of the client

on the environment that system will run inProvide access to appropriate members of staff

Provide facilities for development and testing

Provide accommodation, telephone, secretarial, andother facilities for staff working on clients premises

Provide data links to the site



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Project Management

Parties must also agree on

which standards, methods, quality assuranceprocedures to use

Supplier and client may have different views onthis

arranging meetings to report (and record) progressand completion of milestones

who is responsible for running the project on supplierand client side and specifying the authority of these

persons



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Acceptance Procedure

Critical part of a fixed price contract, as this definescriteria for successful completion

Ideally, client supplies a fixed set of acceptance testsand expected results

Adding extra tests later only by mutual agreement(otherwise this introduces delays and movingtargets)

Should also specify who monitors the tests and whathappens if tests fail to complete successfully



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Warranty and Maintenance

Common practice (after product has been accepted):warranty period of 90 days

All errors found and reported within this period willbe corrected free of charge

Often open to negotiation: the longer the warrantyperiod, the higher the cost

Once warranty expires, supplier may offer maintenance(available on request)

This often involves modifying or enhancing asystems capabilities

Therefore rarely handled on a fixed price basis, buton time and materials (details on this later)



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Other Clauses

Inflation: long-running projects may have a clause onhow charges increase with the rise in costs

Indemnity: one party may cause the other to infringe athird partys rights (e.g. intellectual property)

Each party guarantees to cover any costs for liabilityarising from its own faults

Termination: for risky or long-running projects one partymay want to get out of a contract

Clauses have to specify when and under whichcircumstances this is possible


C ( )


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Other Clauses (2)

Arbitration: in the case of a (legal) dispute, anappearance before court may become very costly,possible alternative could be arbitration

Parties agree to accept the decision of a neutral thirdparty: an arbitrator

In the UK, the BCS or IET maintain lists of qualified

persons, which they appoint

Applicable law: especially important when supplier andclient have registered offices in different legal

jurisdictionsContract states under which laws it is to beinterpreted

In case contract exists in more than one language,also states which version is legally binding


O h T f C


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Other Types of Contracts

A fixed price contract shifts most of the risk to thesupplier

If the requirements of a system cannot be specifiedsufficiently enough, then a supplier

wont tender a bid for fixed price

charge an inordinate amount of money

There are other types of contracts that share the risksdifferently

Contract hireConsultancy

Time and materials (also called cost plus contract)



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Contract Hire

Supplying the client with the services of a certainnumber of staff at agreed rates (daily/hourly)

Client takes responsibility for managing staff

Supplier is responsible for supplying suitably competentpeople

Either party can terminate contract at fairly short notice(typically one week)

Contract hire agreements are much simpler than fixedprice contracts

Many issues, such as delay payments, simply dontarise

Some, however, such as intellectual property rights,still have to be addressed


C lt


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Consultancy

Consultancy projects can be done for a daily/hourly rateor at a fixed price

If done at fixed price, contract is much simpler:

Sums of money involved are usually much smaller

The end product is very often a report, not an actualsystem

Nevertheless, there are some important issues thatneed to be covered


C lt (2)


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Consultancy (2)

Confidentiality: a consultant may not discloseinformation about client learned during assignment

Terms of reference: specify which matters to investigate(and which not)

Can become source of disagreement: consultantsdiscover they need to look at issues outside of

original terms

Liability: consultants usually want to limit their liability(follow advice at your own risk)

Client may insist on adequate liability insurance

Ownership of final report: client is often given a fixedperiod to review a draft before handing over the finalreport


Ti d M t i l


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Time and Materials

Contract hire shifts most of the risk to the client

A time and materials contract tries to balance the risksbetween client and supplier

Supplier agrees to the development of a system similarto a fixed priced contract (i.e. requirements, delivery,acceptance, etc.)

The payment, however, is handled differently

Made on the basis of costs incurred

Labor charged in a similar way as for contract hireSupplier does not have to deliver for a fixed price (oftenmaximum payment may be fixed)

Risks can be managed by agreeing on milestones andtermination clauses


O tso rcing


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Outsourcing

Outsourcing is a contractual arrangement under whicha client hands over a certain business function to asupplier

This usually includes planning, management, andoperation of this function

Very common in some situations: few people generate

their own electricity or drill their own wells

Logic is that a company specializing in a particular area,e.g. catering or office cleaning, is probably better at it

Helps an organization to focus on their corecompetencies


Outsourcing (2)


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Outsourcing (2)

IT services are not that different, people andorganizations have always purchased from third partiessuch as software package suppliers or software houses

However, starting 20 to 25 years ago companies andgovernments handed over whole IT departments

Software companies even started to outsource

programming tasks


Outsourcing (3)


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Outsourcing (3)

IT outsourcing contracts are usually very complex anddepend on individual circumstances

Important points that need to be addressed are

Service level agreements:

How is performance monitored and managedWhat happens if performance is unsatisfactory

Which assets are transferred

Staff transfers

Contingency plans and disaster recovery

Duration of agreement and termination provisions

. . .


Outsourcing (4)


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Outsourcing (4)

Experience has been varied, but not all organizationswere happy with the result

Cost/benefit ratio did not work out

Losing expertise and control

There has been a trend to insource services again

Studies show that the effects of outsourcing have beenoverstated (IMF working paper 04/186)

The US and the UK export more services than they

import


License Agreements


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License Agreements

When customers buy software, they buy a copy and theright to use it in certain ways

In certain ways means: there are different types ofrestrictions in place

Single user license: allows the use of one copy onone machine for one user

Example: computer game

Server license: software can be run on a serverproviding it to any number (up to a maximum) of

users on a certain LANExample: database server

Site license: covers all the users of a system

Example: MyBirkbeck


Liability for Defective Software


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Liability for Defective Software

Almost all software contains some bugs

You have probably seen statements such as

XYZ shall not be held liable for any damagecaused by the use of this software.

or

. . . can only be held liable to a maximum of thepurchase price of this product.

Does this mean that suppliers are off the hook?

Not quite, enter the Unfair Contract Terms Act 1977


Unfair Contract Terms Act


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Unfair Contract Terms Act

A supplier may only restrict liability if its reasonable todo so

If a product causes death or personal injury, its notpossible to limit the damages payable

This refers to software as it does e.g. cars

Assume for a moment that software for controlling airtraffic causes an accident in which people are killed andinjured

Any clause in the supplier contract restricting liabilityis null and void in this case


Unfair Contract Terms Act (2)


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Unfair Contract Terms Act (2)

Death and personal injury are quite extreme cases(most software is not that critical)

In other cases it has to be reasonable for a supplier to

limit liability

What is reasonable in a particular case depends on thecircumstances

Some disputes over reasonableness end up in court


Consumer Sales


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Consumer Sales

In the case of consumer sales (in contrast tobusiness-to-business sales) a consumer has additionalprotection

Sale of Goods Act 1979 and Supply of Goods andServices Act 1982 may also apply (and cannot beexcluded)


Consumer Sales (2)


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Consumer Sales (2)

Sale of Goods Act states that a good must be fit forpurpose

It has never been established if software is a good

General consensus: retail software or software soldunder shrinkwrapped licenses are covered

Tailor-made software, however, is not covered: Supplyof Goods and Services Act applies

This only requires that reasonable skill and care hasbeen used, which can be difficult to disprove in court


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