30 Aug 2012

Changing an outsourcing decision may not be as easy as you think

by Cameron Gascoyne, Simon Newcomb

Customers cannot take outsourced services away from a contractor to have them performed by themselves or others without an explicit right in the contract – a broad right to vary the contract is not enough.

Customers who outsource services usually want the right to end the arrangement or change the scope of the outsourced services to deal with changing circumstances. Outsourcing contracts often contain variations clauses giving the customer broad variation rights. Similarly, termination for convenience clauses are a common feature of outsourcing contracts.

However, these clauses might not give customers the level of flexibility they think.

The general principle – limited right to remove services

There is a general legal principle that a customer cannot remove work from a contractor in order to have that work performed by a third party or in-house, unless the contract clearly allows this.

The general principle was established in the Australian High Court case of Carr v JA Berriman (1953) 89 CLR 327. In that case, a building contract gave the owner the right to omit work from the contract. The owner arranged for certain work to be performed by another contractor, and directed the original contractor not to perform this work. The Court found that the owner's direction beached the contract, saying that "very clear words" would be required for an owner to have that sort of power under a contract.

The general principle is based on the proposition that when a contract is entered that requires a contractor to perform services for a customer, the contractor has not only the obligation, but also the right, to perform those services. The customer should not be able to prevent the contractor from performing the services; this is known as the prevention principle.

A clause that allows a customer to vary or remove services will be effective, but it will only allow the customer to vary services if the varied services will still be provided by the contractor, or remove services only if those services no longer need to be provided at all.

When will a principal have more than a limited right to remove services?

The general principle applies unless parties to a contract use very clear words to displace it. Practically, this means the contract needs to contain an express right for the customer to remove services from a contractor and have those services performed by a third party or in-house. A broad right to vary or remove services is not enough.

Can a customer remove services and perform them itself?

No. Although most of the cases involve work being removed from a contractor and awarded to a third party, there is nothing to suggest the general principle would not apply where the customer removes services to perform those services itself. In both situations, the contractor is being deprived of the right to perform services.

Are the reasons for removing services relevant?

No. It is irrelevant that the customer may have found a contractor who can perform the same services for a better price, or no longer has confidence in the original contractor's ability to perform the services.

In those situations a customer might have other rights under the contract (eg. termination for breach due to non-performance), but it cannot simply remove services under a variation clause to deal with the issue.

Does it matter how many services are removed?

No. The contractor has the right to perform all of the services, so removing an insignificant part of the services and awarding them to a third party would still contravene the general principle.

Can services that were added to the contract be removed?

No. The general principle applies to services added to a contract in the same way that it applies to the original scope of services.

Can a customer use a termination for convenience clause to get around the general principle?

Possibly. If a termination for convenience clause is clearly drafted to allow the customer to terminate its contract in any situation, then the customer may be able to terminate the contract in order to have the terminated services performed by someone else.

The final word

If a customer wants the right to remove services and have them performed by someone else, then the contract should expressly deal with this. If it does not, then interfering with the contractor's right to perform work could lead to a claim against the customer for breach of contract or repudiation.

Customers should review the variation and termination clauses of existing outsourcing contracts carefully before relying on them to change an outsourcing decision.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.