Prepared but not presented at IT.Can Annual Meeting

1. 1
Trends in IT Contracting
Guarantees
Adam Vereshack
Canadian IT Law Association
14th Annual Conference
October 28, 2010

2. 2
Nature of the Guarantee
 Normally, a guarantee is an obligation by the guarantor to pay the
Customer a fixed or calculable amount should the Supplier breach its
obligations
 However, when dealing with IT agreements, the payment of money may
not be a sufficient remedy as the work is not something that the Customer
can simply hand off to another supplier to complete (like completion of a
highway)
 Rather, the Services are comprised of a complex set of technical services
using specially trained employees of the Supplier
 As a result, the guarantee must include both (i) an obligation to make
payments to the Customer that the Supplier failed to make, and (ii) to
continue to provide the Services that the Supplier failed to perform.

3. 3
Material Adverse Change
 Agreement should include a provision that addresses
a material adverse change in the financial condition
of the guarantor (a “MAC”) and the results of any
such change
 When dealing with the occurrence of a MAC, there
are two distinct issues that need to be addressed
 First - what constitutes a MAC
 Second - what remedy should the Customer look for
if an agreed-upon MAC occurs

4. 4
Material Adverse Change
 What should constitute a MAC will depend to a large degree
on whether the guarantor is a public or a private company. If
it is public, the matter is relatively simple:
 All that the Customer and the guarantor need to agree to is
what change in the guarantor’s credit rating below a certain
level is to be a MAC
 One commonly used criterion:
 If the credit rating of the guarantor falls below ‘investment
grade’ as determined by the agreed-upon rating agency

5. 5
Material Adverse Change
 However, if the guarantor is not a public company and there is no clear
objective test such as a rating agency’s credit rating of the guarantor, the
question as to what should constitute a MAC becomes more complicated
 While there are many tests that could be applied, suggest that the
Customer set the threshold for a MAC at whatever the Customer
determines at the time acting reasonably
 While this may initially appear to be too open-ended for a guarantor to
agree to, the reasonableness test gives the guarantor both the opportunity
to argue the Customer’s determination and ultimately to take the matter to
dispute resolution
 However, it is critical that the agreement be drafted such that the
guarantor only be able to challenge the Customer’s determination of a
MAC after the Additional Security (defined below) has been implemented
to ensure that there is no delay in the establishment of the Additional
Security

6. 6
Results of a Material Adverse Change
 Irrespective of whether the guarantor is a public or a private company,
the Customer needs to consider what provisions should be included into
the agreement should a MAC occur
 The Customer must consider what it needs from a credit risk point of
view
 Normally, Customers faced with a MAC will want an additional form of
security (“Additional Security”) that is immediately available to the
Customer should the need to draw on the Additional Security arise
 One common remedy is to require the Supplier (or possibly the guarantor
depending on the circumstances) to establish a letter of credit (an “L/C”)
as Additional Security in favour of the Customer in a very short period of
time

7. 7
Results of a Material Adverse Change
 In order to do this, it is recommended that the parties
set out a sample L/C in a schedule to the agreement
so as to avoid any delay in establishing one within a
very short period of time if (when) needed
 It is also suggested that, in addition to the amount of
the L/C, the agreement should also specify that the
bank be acceptable to the customer in its sole
discretion and the L/C be drawable at the bank’s
offices in the city where the Customer is located

8. 8
Cure of a Material Adverse Change
 In fairness to the Supplier and the guarantor, the Customer
should include provisions permitting the Additional Security
to be terminated should the guarantor be able to demonstrate
to the Customer that the MAC has been rectified.
 While the change of the credit rating back to ‘investment
grade’ cannot really be contested by the Customer, in the case
where the guarantor is a private company, the Customer
should ensure that it has the right to contest the Supplier’s
notice that the Additional Security is no longer required as
the MAC has been remedied.
 Such challenge should be in accordance with the agreed-upon
dispute resolution procedures set out in the agreement.