IT contracts: Dealing with the risk of supplier insolvency

IT contracts: Dealing with the risk of supplier insolvency


Author: Andrew Pickin

The collapse of systems integrator and reseller 2e2 in January has highlighted the danger for clients of companies such as 2e2, and focuses attention on how to deal with this type of situation.

At a recent Shoosmiths event, data, IT and banking lawyers shared practical experience of the risks and potential remedies associated with insolvency of IT suppliers.

Main risks discussed included:

  • heavy reliance on one supplier and lack of contingency arrangements if that supplier fails¬†- 1,800 IT sector organisations became insolvent from 2009-11
  • rights of administrators to refuse to perform contractual obligations of an insolvent supplier
  • lack of appreciation in the client's organisation of the critical applications provided by suppliers, which can lead to paralysis following an insolvency event
  • concern that users do not understand the vulnerability of cloud-based offerings

Attendees at the event, one of a series run by Shoosmiths' Commercial Team for in-house lawyers and IT professionals, then discussed how they could strengthen their resilience against supplier insolvency.

A number of interesting points emerged, including the limited practical use of escrow arrangements.

Some practical solutions and mitigating measures included:

  • regular visits to suppliers in the context of pre-contractual due diligence and also as part of ongoing contract management strategy, to check suppliers' ongoing viability and resilience to risk
  • take control of critical bespoke software applications by developing them in-house, if possible
  • be very sure you understand the rights you have to use critical software - a short-term licence may not give you the security you need
  • spread the risk across several suppliers, rather than relying on one critical provider
  • if you choose to use the deposit of source code in escrow as a means of protection, recognise the importance of keeping the materials up-to-date, and think through the practicalities of using the code to rebuild your systems
  • consider carefully how you could retrieve your data if a supplier fails

2e2's administrators FTI Consulting have confirmed they are unable to sell the company as a going concern, leading to the immediate loss of 627 UK jobs. These are in addition to 345 redundancies made by 2e2 as it went into administration.

Apart from the very real human cost of business insolvency, there will be expensive implications for those 2e2 clients unable to put in place adequate contingency measures - while those that considered the possibility of a worst-case scenario from the outset will have protected their interests in various ways. They are now very relieved that they did.