Tuesday, March 16, 2010

"D" is for Damages

The project is late.  Your team leader had emergency surgery, an earthquake put the server manufacturer two months behind in deliveries and Customer did not tell  you about a  half dozen legacy programs written in Fortran that require customized interfaces to operate with the new system.  You have just received a polite message from Customer that each day of delay is costing $10,000 in lost opportunities, and would you please pay up.  Are you liable?

In this scenario, the answer is "Probably not."  The delay in receiving servers, and the illness of your team leader would be events beyond your control, and would be covered by standard force majeure language,  which reads roughly:

"Neither party shall be liable to the other for loss, delay or disruption caused by events or circumstances beyond the control of said party, such as war, natural disaster, labor unrest or government intervention."
As for the $10,000 per day, the contract should contain language that excludes liability for lost business, lost opportunities and lost profits. More than that, you can object that the claim is speculative, that Customer cannot prove that he would have realized the 10 grand per day but for the delay in completing the new system.  Courts do not like to make awards if the damages cannot be quantified with relative certainty.  

Another scenario:  You deliver the system on time and on budget.  Two days before the warranty expires, you receive a report that smoke is rising from the new server array.  By the time you arrive, the heat from the servers has set off the sprinkler system and everyone at Customer's data center is irate and dripping wet.  Worse, when the data center went down, it took Customer's national network with it, the switch over to a back up center having failed.  When the data center is back in order, Customer discovers it has lost ten years of vital statistical data.  An investigation makes it clear that the initial problem - the over heating, and then the fire in the servers, was caused by your team.  Someone did not follow the manufacturer's instructions.  What do you owe Customer?

Part of the answer is easy - new servers, or repair of the originals.  The force majeure exception would not apply, because this failure was one your team could and should have anticipated and guarded against.  The law calls such damages, which are the reasonably foreseeable consequence of an error or omission "direct damages."  Direct damages are typically recoverable to the extent needed to make the injuried party "whole."  

The meaning of "whole" can lead to much litigation.  In our example, must you:

  • Provide Customer with brand new servers of the same model and configuration?
  • Repairs to the original servers?
  • Servers of the same model and configuration, but refurbished by a third party?
  • New servers using a new generation of processors, which just came out and cost one third more than those you originally installed?
The last option - new servers with new processors can probably be excluded, as that would be a windfall for Customer.  He/she would be better off than before the failure.  But what if Customer wants the first option - new servers, and asks that you pay for them to be installed by your competitor?  Would the extra cost - paying your competitor - be a windfall to Customer or merely make Customer whole?  That is a question only the litigation attorneys would enjoy.  Thus a carefully drafted contract will provide that the remedy will be repair or replacement at vendor's option.  A very carefully drafted contract will also protect Customer - adding provisions to ensure that the work is done promptly and correctly.

What of the other damages - the network disruption, the cost of cleaning up from the sprinkler, the lost data?  The network disruption might turn on another question - why did the back up fail?  That is a question Customer needs to take up with its back up provider.  The lost data and the sprinkler clean up, however, are arguably "consequential damages" - they are indirect and unforeseeable results of the failure.  Consider: Shouldn't Customer have  had off site back up for the data, if it was critical to continued operations?  Was it reasonable design a sprinkler system that would inundate the entire center in response to a fire in one area?  Standard contracts routinely exclude liability for such remote, indirect and unforeseeable damages.

Assume the court (the jury and the judge) determine that it was foreseeable that a fire would trigger the sprinklers, which would damage equipment.  Are you liable for the entire cost of replacement equipment and clean up?  Here the limitation of liability provision of the contract would come into play.  Standard language will cap the potential liability of both parties, either at a dollar limit (e.g.  "shall not exceed $X") or using a formula, such as "X times the fees paid...."  Another approach is to tie the limit to the insurance coverage carried by the parties.  This method has the advantage of making sure there is a "deep pocket" - the insurer - on  hand in the event of a claim.  Of course the parties must take care to require that both carry adequate insurance, from reputable, financially sound companies.  

Questions we will address in the future:
  • Appropriate insurance language
  • Appropriate responses to a force majuere event
  • Who should pay for the interfaces mentioned in the first paragraph, and why.

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