Sears, CSC fighting over IT contract termination fees

The outsourcer claims it's owed $96M; Sears alleges breach of contract

Sears, Roebuck and Co. ended its 10-year, $1.6 billion IT outsourcing agreement with Computer Sciences Corp. after just 11 months. But the companies now face arbitration on a prickly dispute over the grounds of the cancellation and whether Sears has to pay termination fees to CSC.

At stake, according to motions that CSC filed April 25 with the U.S. Court of Appeals in Chicago, is roughly $96 million in termination fees. CSC claims that is the amount Sears should have to pay to end the contract.

Sears said in a May 11 filing with the U.S. Securities and Exchange Commission that it had cause to pull out of the contract, citing CSC's "failure to perform certain of its obligations." The retailer added that it expects to incur no "material" penalties as a result of the termination.

But in its own SEC filing last week, CSC countered that Sears' attempt to end the contract for cause was "contrived to avoid or reduce" the termination fees that the outsourcing vendor says it is owed.

CSC argued in its motions filed with the Court of Appeals -- from which it unsuccessfully sought an injunction to stop Sears' move to cancel the contract for cause -- that Sears terminated the agreement "for convenience due to change of control" as a result of the retailer's merger with Kmart Holding Corp. The merger, which formed a new parent company called Sears Holdings Corp., was announced in November and completed on March 24.

If Sears and Kmart had completed their merger and canceled the contract by March 2, the fee for a convenience termination would have been about $58 million, El Segundo, Calif.-based CSC said. It noted that the fee increased to $96 million if the termination notice came within 90 days of June 1, the one-year anniversary of the contract signing date.

Sears and CSC will continue to work together, despite legal wrangling.
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Sears and CSC will continue to work together, despite legal wrangling.
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According to CSC, during a Feb. 18 conference call, Sears' CIO at that time, Gerald Kelly Jr., read from a script, asking CSC to cap the charges at $58 million for a termination for convenience initiated prior to May 31. "If CSC does not choose this path, we will be forced to consider declaring a material breach under the agreement," Kelly was quoted as saying. In its motions, CSC said it "refused to submit itself to Sears' extortion tactics."

In documents filed in court by Sears, though, the Hoffman Estates, Ill.-based retailer said it had notified CSC of 65 individual breaches of the agreement since the contract took effect. Sears claimed that CSC's performance was "a dismal failure from the start" and by September had become "so poor that [CSC] was forced to summon a 'red team' from its corporate offices to assess its deficient performance."

According to Sears, CSC graded itself as poor in nearly every category of contract performance, including service delivery, project planning and tracking, and team organization and strength.

Sears said it provided CSC with formal written notice on March 18 that the IT services firm had been in material breach of the agreement for several months and that it expected CSC to "cure" the breaches within 30 days.

Requests Denied

Meanwhile, CSC claimed that on the same day, prior to receiving Sears' notice, it filed suit in U.S. District Court in Chicago seeking a temporary restraining order and preliminary injunction to stop Sears from terminating the contract for cause. It also asked the court for a declaratory judgment that it had not materially breached the contract.

Without ruling on the merits of the case, the district court judge denied CSC's requests. A representative for the district court said last week that the records of the case were not available. However, both Sears and CSC said in their appeals court documents that the judge ordered them to begin arbitration. CSC requested emergency arbitration, but that was also denied, according to Sears.

Sears and CSC declined to comment on the court cases and arbitration proceedings last week, as did lawyers for both companies.

John Thomas, a technology law partner at Squire, Sanders & Dempsey LLP in Tysons Corner, Va., said he hasn't seen many long-term outsourcing deals become as "publicly messy" as the CSC-Sears one has. But he noted that the fees for terminating contracts for convenience are typically significant so vendors can recoup their heavy upfront expenses.

"The process of gearing up, bringing in people and all the work that goes into the first six to 12 months of an outsourcing relationship is very expensive," Thomas said.

Even so, Akiba Stern, an attorney at Morgan, Lewis & Bockius LLP in New York, said it's likely that CSC and Sears will settle the case privately, as parties involved in these types of disputes typically do.

In its SEC filing, CSC said it also will "vigorously pursue recovery" from Sears for the investments and commitments that the outsourcing vendor made in connection with the contract, including its spending on software, property and equipment.

Despite their legal differences, the two companies continue to work together on IT matters. CSC is obligated to provide IT services to Sears for an unspecified period following the termination, according to the retailer's SEC filing.

The contract called for CSC to provide IT infrastructure support services for Sears' desktops, servers, Web site systems, voice and data networks, and decision-support technology.

Copyright © 2005 IDG Communications, Inc.

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