Many contracts for services these days include key performance indicators (KPIs) and/or service levels which are used to measure the capability and effectiveness of the service provider.  We see these all the time and they are usually an important element of the contract for the client, because linked to them are often rights to deduct contract payments – service credits – and, where there is consistent or substantial underperformance, to terminate the contract.  Why would any company want to be locked into a contract with a provider who was not performing to the required standards?

When we draft and negotiate contracts of this type, we work closely with our clients’ commercial and finance executives who identify the areas of service provision which are of particular importance and value to them.  We then jointly construct and set out mechanism for measuring and reporting on the relevant KPIs.  These can develop into quite complex structures; particularly if a balanced scorecard approach is being taken and where the structure provides not only for penalties if there is underperformance, but also includes financial incentives to the service provider for over-performance.

What is crucial is that as lawyers, we have a very clear understanding of these issues so they are effectively incorporated into the contract.  Unfortunately, cases occur where even though it must have been blindingly obvious to all of the commercial parties involved what was meant by a particular KPI mechanism, this is not properly reflected in the contract drafting and so provides scope for disputes when things go wrong.

This was the situation the Court of Appeal had to rule on a couple of weeks ago in the case of Sutton Housing Partnership Ltd v Rydon Maintenance Ltd [2017] EWCA Civ 359 (18 May 2017) [http://www.bailii.org/ew/cases/EWCA/Civ/2017/359.html].  Rydon Maintenance Ltd (Rydon) is a maintenance contractor which entered into a contract in 2013 with Sutton Housing Partnership (Sutton) to provide repairs and maintenance to Sutton’s large portfolio of housing.  It was a 5 year contract and contained a number of KPIs against which Rydon was to be measured.  For example, there was a KPI for Repairs completed right first time (2014/15 target 97%) and one for Resident satisfaction with communal repairs (2014/15 target 96%).  The contract also referred to Minimum Acceptable Performance levels (MAPs) and gave Sutton the right to terminate the contract early if these MAPs were not achieved.  During the period in dispute, Rydon’s actual performance against these two KPIs was 74.5% and 61.5% respectively.

Strangely, however, despite the clear reference to MAPs, the table of KPIs did not expressly specify what the MAP was for each KPI.  It did set out the targets for each KPI and it included a provision allowing Sutton to reset these in the later years of the contract.  The KPI provisions also set out how Rydon would be financially incentivised for exceeding its KPI targets and financially penalised for failing to achieve them.  The only place where MAPs were shown were in a number of calculations which were included in the contract as examples to show how these penalties and incentives would be calculated.  It was pretty clear from those examples that in every case, the MAP was 3% below the target KPI.

But the Court of Appeal was extremely cautious about applying a common sense test to resolve the dispute before it.  Sutton had sought to terminate the contract due to Rydon’s failure to achieve MAPs.  But both in an adjudication and then on appeal to the Technology and Construction Court, Rydon had successfully argued that because the contract did not clearly set out the MAPs for each KPI, it could not be terminated on the grounds of failing to achieve any MAP.  The courts in England and Wales are very reluctant to imply a term into a contract which has been negotiated between two commercial parties even if by not doing so, one party will clearly suffer a commercial disadvantage.   It is worth noting the comments of Lord Justice Jackson in his judgement on this case.  He said “While commercial common sense is a very important factor to take into account when interpreting a contract, a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed. Experience shows that it is by no means unknown for people to enter into arrangements which are ill-advised, even ignoring the benefit of wisdom of hindsight, and it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice”.

Having made that point, the court then went on to find (much to Sutton’s relief, no doubt!) that any reasonable person in the parties’ position would have intended the contract to contain MAPs and the MAPs used in the example calculations were the correct ones to apply.  This meant that Sutton was entitled to terminate the contract for Rydon’s failure to achieve the MAPs.

The time and – no doubt considerable cost – of this lengthy legal dispute could have been avoided if the contract had originally been clearly drafted to reflect what both parties had almost certainly intended.  It is a salutary reminder that putting together a commercial contract is a team effort and it is important for lawyers and their clients to work closely to ensure the important commercial terms are accurately and effectively reflected in the final agreement.