Contractors seek to cap project liability

Contractors are trying to enlist state chief information officers in a campaign to get state governments to lift unlimited liability clauses from contracts.

The clauses expose contractors to unlimited monetary risk if something goes wrong and are discouraging companies from doing business, industry officials said. Many large systems integrators fear that major problems on a contract where unlimited liability is in effect could result in damages that would severely harm their companies.

For example, American Management Systems Inc. of Fairfax, Va., was forced to pay Mississippi $184 million in damages on an $11.2 million tax project that went awry.

Industry members of the National Association of State Chief Information Officers have asked the group to use its influence to get the unlimited liability clauses changed.

Richard Thompson, chairman of NASCIO's procurement committee and Maine's CIO, said technology companies want states to establish standard liability limits for use on contracts within their jurisdictions.

"If companies can identify the risk, then they can put a price to it," he said.

Standard liability limits are based on a concept known as true risk. True risk is the actual cost incurred by a state government to provide a particular service or function if there is a failure to perform.

Because contractors are being scared away by unlimited liability clauses, state governments are not getting the best services available on some projects, government and industry officials said.

Among the large companies that are lobbying against unlimited liability are Accenture Ltd., IBM Corp. and Microsoft Corp., sources said.

States have defended using unlimited liability on the grounds that, because they hold the public trust and are purchasing on behalf of their citizens, they are entitled or required to demand substantial compensation for nonperformance.

What's more, in some states, attorneys general have issued opinions identifying legal obstacles to adopting limitation of liability clauses that block using such clauses in IT contracts.

While some states are willing in certain instances to accept limited liability clauses based on contract value or twice the contract value, others are not, said Robert

Metzger, a partner in the government and commercial contracts practice with Los-Angeles law firm Gibson, Dunn and Crutcher LLP.

"In those states, the leading IT firms will do a risk assessment of the business opportunity and often will choose not to bid, because the value of the business is not worth the risk," Metzger said. "When that happens, it reduces the extent of competition and the quality of participants."

Liability limitations on state contracts rarely come near those that are common on commercial contracts or even those imposed on federal contracts through Federal Acquisition Regulation Part 12, Acquisition of Commercial Items, he said.

At its annual meeting last month in New Orleans, NASCIO released a report recommending that CIOs encourage their states to use true risk to set contract liability. The report recommends that states hold contractors responsible for direct damages only and not for third-party claims arising from indirect damages.

States also should specify how the value of the contract will be calculated when the liability is expressed as a multiple of the contract's value if contract extensions or multiyear contracts are involved.

Many states will require changes in law to allow limited liability, government and industry officials said.

Nearly a dozen states have agreed to terms that limit liability on some of their IT contracts, Metzger said. Of those, California and New York are serving as models of reform for other states, he said.

To align its liability provisions with the commercial sector, California usually sets liability at twice the value of the contract, Metzger said.

New York has agreed to set liability at twice the value for its $1 billion statewide wireless network project, said Susan Zeronda, deputy director and chief counsel for the New York Office for Technology, at NASCIO's annual meeting.

Other states that have agreed to terms that limit liability on some IT contracts include Florida, Idaho, Maryland, Nevada, New Jersey, North Carolina, Ohio and Virginia. Tennessee passed legislation this year that sets liability for technology and telecom contracts at twice the contract amount. Georgia, Louisiana, Maine, Nebraska and South Carolina have said they cannot agree to limit liability.

For states to go from unlimited liability to twice the contract value as the maximum liability is a significant improvement, said a large systems integrator official who asked to remain anonymous. A willingness to cap liability comes at a time when companies are inclined to pass on projects in which unlimited liability is a provision.

"Unlimited liability on a contract is very disconcerting," the official said. "We don't want to take it on, regardless of the return."

Staff Writer William Welsh can be reached at wwelsh@postnewsweektech.com.
It was every contractor's nightmare: A complex project gets bogged down with cost overruns and delays until finally the customer terminates the contract and sues.

When American Management Systems Inc. of Fairfax, Va., failed to deliver an automated tax system as part of a three-year, $11.2 million project in Mississippi, the state sued the company six years later for nearly $1 billion. A jury ruled in favor of the Mississippi Tax Commission and ordered AMS to pay $474.5 million in actual and punitive damages.

After considering launching an appeal, AMS agreed in 2000 to pay the state $184 million over 13 years.

Although AMS' insurance companies eventually covered the costs, the settlement remains a hot topic. If the Tax Commission had followed the liability guidelines proposed by the National Association of State Chief Information Officers of Lexington, Ky., it might have sued only for twice the value of the original contract -- a fraction of the final settlement.

AMS, which was purchased by CGI Inc. of Montreal earlier this year and renamed CGI-AMS, declined comment for this story.

If an IT contractor were to avoid any state since then, it might be Mississippi. But that hasn't been the case, said David Litchliter, executive director of the Mississippi Department of Information Technology Services and the state CIO.

"I've not been aware of any vendors choosing not to bid in the state because of financial liability, [although] I'm sure there have been situations where a vendor chose not to propose due to potential liability or other risks associated with a particular project," he said.

Still, most of the major IT contractors compete for business on a regular basis in Mississippi.

The state legislature gave Litchliter's department the power to negotiate limits on liability for IT contracts in 1998, he said. Since then, the department successfully has negotiated IT contracts with companies that were awarded business in the state. The Tax Commission awarded AMS the contract in 1993 and had no limit on liability.

"I believe our history of 'reasonable' negotiated limits on liability has allowed the vendor community to more effectively evaluate the risk associated with a particular project, and thereby encouraged additional competition and reduced the cost of IT services to the state," he said.

The department does not have a set limit for liability because "different projects, vendors and project approaches represent different levels of risk to the state," he said.

But he said that limits typically range from one to three times the contract value. The negotiated limits also are influenced by other terms, such as liquidated damages and performance bonds, he said.

In nearly 30 years, Mississippi's IT department has resorted to litigation only twice and failed to negotiate a settlement out of court just once.

"I don't know what those numbers look like in other states, but I would guess that a comparison would put us in the 'vendor friendly' category," Litchliter said.

 

Liability for direct and indirect damages

• States should hold vendors responsible for direct damages arising from a contract.


• States should not hold vendors responsible for third-party claims arising from indirect damages.


• Unless responsibility is allocated specifically to the vendor in the contract, the state should not hold vendors responsible for indirect damages, including special or consequential damages.

• Vendor liability should be limited in correlation to the risk associated with the contract. Opinion varies as to the accepted amount of liability in relation to the value of the contract, although twice the value of the contract appears to be at the high end of the range. However, liability limitations in excess of twice the value might be warranted for high-risk contracts, such as for state IT systems that involve public safety or homeland security.


• If a contract contains a liability limitation that is a multiple of the total amount, the state and vendor should address specifically how the "amount of the contract" should be calculated. This is especially important when a contract has an extension clause or other type of unique funding mechanism, such as when the contract is multiyear but only funded for a portion of its term.

• States should not cap a vendor's liability for copyright or patent lawsuits.

• States should not cap a vendor's liability for death or bodily injury lawsuits.

• States may not be able to waive their sovereign immunity rights, which are constitutional or statutory rights to protect the government as well as the citizenry. States are encouraged to consult with their legal counsel to determine their individual sovereign immunity requirements and whether they have any flexibility to waive those rights.