Grindgut judgment

by Inge K. Brodersn

Published:

Abstract pillars

Borgarting Court of Appeal recently passed judgment in one of the largest information technology contract disputes ever to be processed by the ordinary courts in Norway, the so-called "Grindgut" case. The disputing parties were the Norwegian Ministry of Transport (Nw. "Samferdselsdepartementet") and International Business Machines AS ("IBM") and concerned a contracted project under which IBM were to design, construct and deliver to the Norwegian Public Roads Administration (Nw. "Statens Vegvesen", hereinafter "SVV") a new centralized road toll system across Norway called "AutoPASS Grindgut". In this article, Inge Brodersen takes a closer look at the case and its main legal topics.

The background and contract


The contract for the design, development and delivery of the road toll system between SVV and IBM (the "Delivery Contract") was concluded on 20 December 2013 after a public procurement process involving several bidders. At the same time, the parties also concluded three other agreements for operations, maintenance, development and consultancy assistance, as well as for financing.


IBM had relevant experience from projects involving IBM's "Road User Charging Asset" ("RUC") which had been used in Stockholm, Brisbane and London. IBM originally planned to arrange development for SVV as a global delivery with one delivery center locally in Norway and five delivery centers in India and China, with a large offshore ratio at 70 %.


The project execution


The Delivery Contract was based on the Norwegian standard template PS2000 (titled "Contractual standard for the delivery of software etc."), which is designed for system development projects that are not possible to set out in detail in advance. The PS2000 template can be characterized as a hybrid between the classic "waterfall" system development contract and a more agile/iterative type of contract, as the construction phase is based on iterative processes between the parties.


As originally agreed in the contract for this particular project, the main milestones ("HMP"s) were HMP1 "Approved solution specification" on 13 February 2014, HMP2 "Delivery ready for approval" on 14 October 2014 and HMP3 "Approved delivery" on 19 March 2015. The project was significantly delayed in the solution specification phase, and it took twice as long as planned. HMP1 was approved with reservations on 4 July 2014, almost 5 months later than originally planned. The challenges continued in the construction phase, which was ultimately never completed.


On 22 June 2015, SVV notified IBM of its intention to terminate the Delivery Contract for cause due to both actual and anticipated material breach on IBM's part. On 27 July 2015, SVV declared to IBM that the Delivery Contract had been terminated, as well as also the other aforementioned agreements.


IBM rejected SVV's termination, claiming that it was wrongful and as such it was a material breach. IBM then terminated the financing contract for cause on 5 August 2015, and the Delivery Contract and the other remaining contracts on 14 August 2015.


The legal proceedings at Oslo District Court


On 29 March 2016, on behalf of the Norwegian government, the Norwegian Ministry of Transport sued IBM before Oslo District Court. The legal proceedings lasted 47 days from 18 March 2019 to 14 June 2019.


The Norwegian Ministry of Transport alleged that the main cause of the project's failure was that IBM had underestimated its scope and complexity. This led IBM to cut costs, reduce staffing etc., and IBM lost control of the project. SVV had a right to terminate both for actual material breach and for anticipated material breach. The Norwegian Ministry of Transport claimed damages calculated at the court's discretion, based on an alleged claim for recovery of 4 loss components (in addition to legal fees): 1) a loss of at least 270 MNOK for having to extend the existing system until a new system was implemented, 2) project cost of 102 MNOK, 3) cost of new procurement process of 20 MNOK and 4) cost of operators and toll companies of 2,2 MNOK.


IBM told a completely different story. According to IBM, the main cause of the failure of the project was increased scope which was due to SVV. IBM had based its estimates on use of standard functionality in RUC, to ensure a swift implementation. Through lack of goal orientation by SVV and lack of internal anchoring on the customer side, the solution was forced from standard functionality to tailor-made development. SVV's termination was wrongful and constituted deliberate material breach of the Delivery Contract. IBM claimed appr. 177 MNOK for fees under the Delivery Contract, 61 MNOK for fees under the financing contract, and 20 MNOK for cancellation fees under the various contracts.


On 31 January 2020 Oslo District Court decided that SVV's termination of the contract for cause was wrongful[1]. By and large the court followed IBM's narrative, and it criticized SVVs approach to the project. The court found that, in line with SVV's submissions, IBM underestimated the scope of work that followed from the solution description and that they had low productivity through large parts of the project (judgment p.21). Nevertheless, it was stated in the judgment that: "There are (...) circumstances that can be attributed to SVV, which stand out as the main reasons why the cooperation broke down. These together constitute a material breach of the customer's duty of contribution." Furthermore, the court scolded SVV for having drained IBM's ability to lead the project by its "micro-management" and drive towards tailor-made solutions.


In the court's view, the demonstration during the legal proceedings of the interaction between the project's solution and implementation showed that there was no material breach by IBM at the time of termination. Additionally, there was no anticipated material breach by IBM as it was not clear that IBM would have exceeded the applicable milestone for delivery by more than 100 days, which was the contractual limit for material delay. The court believed that IBM had developed 78% of the solution in June 2015, with a monthly progress of 7-8 percentage points. The court therefore found that it was not unlikely that IBM would have reached the next milestone in time.


IBM was acquitted in respect of all claims from SVV, and SVV was sentenced to pay to IBM 136,5 MNOK in contractual fees, 2,5 MNOK in damages, 60 MNOK in interest, plus legal fees of 42 MNOK.


Unsurprisingly, SVV disagreed with the reasoning of Oslo District Court appealed to Borgarting Court of Appeal.


The legal proceedings at Borgarting Court of Appeal


The legal proceedings at Borgarting Court of Appeal lasted for 56 days from 13 January 2022 to 6 May 2022. On 14 October 2022, the court passed its judgment[2].


In chapter 3 of the judgment, the Court of Appeal considered the main issue in the dispute, i.e., whether SVV had a right to terminate the Delivery Contract for cause for actual and/or anticipated material breach by IBM.


The court firstly discussed the question of whether IBM was in actual material breach of the Delivery Contract at the time of SVV's termination declaration of 27 July 2015, considering the Delivery Contract's termination clause as well as other legal sources such as the case law and legal theory. The court's methodology is exemplary: First, the court explains that a termination notice of one party must identify and specify all factors leading to the alleged material breach by the other party, i.e., that the termination notice provides the "frame" for the termination declaration. Without such identification and specification, it would not be possible for that party to rectify the (alleged) breach. Also, after the notification, it is not possible to assert other factors as grounds for terminating for cause, e.g., in the termination declaration.


The court clarified that the right to terminate due to material breach by the supplier under these types of IT contracts is primarily connected to the main obligation of the supplier to the obligation to deliver, i.e., the "result obligation". The relevant clause also provided that the right extended to secondary obligations, such as the project management obligation. However, the court emphasized that there is a high threshold for termination due to a breach of these secondary obligations.


The court then applied the above principles. It specified the "frame" of SVV's termination notice, and it pointed out that the termination notice by SVV only pertained to secondary obligations of a supplier, more specifically factors related to IBM's project management. The court moved on to assess each of these factors specifically, e.g., whether IBM had provided a realistic execution plan, diligent progress reporting (including "earned value" reporting), adequate tools, resources etc.


Of all these factors, the court found that only the "earned value" reporting was lacking to the extent it could be deemed a "breach" and it did not find it considered "material".


Secondly, the court assessed whether there were grounds for anticipated material breach. Much like the Oslo District Court, the Court of Appeal reached the conclusion that IBM would have been able to deliver in time before any time limit for material delay.


In other words, the court found neither an actual material breach at the time of SVV's termination declaration, nor any anticipated material breach. SVV's appeal was rejected. SVV was sentenced to pay to IBM 172 MNOK in contractual fees – more than in the previous judgment - and 2,5 MNOK in damages, plus interest of 60 MNOK, as well as legal fees of 37 MNOK.


Key Takeaways


While all IT projects are different, there is no doubt that the "Grindgut" case provides a wealth of useful information for legal practitioners, procurement professionals, IT project consultants and management. Several of the legal topics in the case are recurring themes in most IT projects of some complexity, and rarely have they been discussed as thoroughly as in the judgments of both court instances in the Grindgut case.


In the following we list some of the most important "take-aways":


Termination for cause requires thorough prior legal assessment and careful adherence to termination procedures


The ruling is a reminder of the severe danger of terminating a contract prematurely. A wrongful termination can constitute willful and material breach of contract, turning the case on its head and providing the other party a right to terminate for cause. In addition, any liability caps in a contract are likely to be void due to the deliberate nature of the breach.


Furthermore, the ruling illustrates that if a party is to terminate the contract, there must be a direct correlation between the termination notice and the subsequent termination declaration. This means that if one declares termination on a basis that has not been notified, the termination may be rejected because the wrong procedure has been followed. This also means that the wording of the termination notice is crucial.


Interestingly, this was also one of the main take-aways from one of the other largest information technology disputes before the ordinary courts in Norway in recent years, namely the "Felleskjøpet" case, which also ended favorably for the supplier. On 13 July 2021, Eidsivating Court of Appeal handed down a verdict in an appeal between the customer Felleskjøpet Agri SA and the supplier Infor (Steinhausen) II GMBH[3]. The supplier was acquitted of the customer's claim for compensation and awarded compensation of more than 84 MNOK, as well as legal expenses totaling approximately 50 MNOK.


It is safe to say that these two cases have made it clear that terminating for cause in complex IT projects is a risky endeavor. It requires thorough prior legal assessment of all relevant parameters – such as the thresholds for termination for breach of main obligations versus secondary obligations. It also requires careful adherence to termination procedures in the contract and in background law.


The friction between standardized solutions versus tailor-made solutions is a significant risk for IT projects


The "Grindgut" case illustrated a well-known cause of friction in system development projects generally between the customer's growing desire for tailor-made solutions and the initial goal of utilizing standardized solutions. We have seen this in many other cases as well, and the friction is often caused by a lack of coordination and internal anchoring on the customer side. There is obviously no quick fix to this issue given that it has hampered public sector projects for decades. However, being aware of it and acknowledging the need for discipline and coordination within the customer organization is a start. The topic can also be seen as part of a larger problem –customers' tendency to procure unnecessarily large and complex IT projects.


The customer has extensive obligations to contribute


As mentioned, the Oslo District Court criticized SVV's interference with IBM's project management, indicating that SVV conducted counter-productive "micro-management" of IBM. Understanding the customer contribution obligations in these kinds of contracts is under-communicated and should be prioritized. Based on the descriptions in the "Grindgut" case, it may seem that SVV -focused too heavily on areas where it would have been more efficient to let IBM be in charge to the detriment of mutual interaction and collaboration, and as such it was in breach of the contribution obligations. In other cases, we have seen the opposite, which can be just as detrimental, namely that the customer more or less completely disregards the contribution obligations and leaves everything to the supplier in a project which requires the involvement of both parties. This topic underscores the importance of a solid project methodology, which should ideally be prepared in collaboration between both parties.



[1] https://lovdata.no/pro/#docume...


[2] https://lovdata.no/dokument/LB...


[3] Lovdata: https://lovdata.no/LESIV/avgjorelse/le-2018-76187-3