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State, IBM contest $62 million award for canceled welfare contract

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Indiana Court of Appeals judges spent the better part of a 90-minute oral argument Nov. 25 focused on whether a trial judge’s order applied the proper legal standards in awarding $62 million to IBM after the state canceled its $1.3 billion contract to overhaul Indiana’s welfare administration.

Marion Superior Judge David Dreyer in July 2012 awarded IBM $52 million plus about $10 million in prejudgment interest after the state negated the 10-year deal involving the Family and Social Services Agency after just three years.

apb-il-ibm03-15col.jpg Arguing for the state, Peter Rusthoven tells the Court of Appeals a $62 million judgment for IBM should be vacated. (IL Photo/Aaron P. Bernstein)

In State of Indiana v. IBM, 49D10-1005-PL-021451, Barnes & Thornburg LLP partner Peter Rusthoven argued for the state – to the sometimes skeptical appellate judges – that the record was replete with evidence that the contract was canceled for cause.

“The trial court ruling was clearly erroneous,” Rusthoven said. He argued that IBM officials promised more than they could deliver in promoting an advanced, totally computerized welfare-intake system, then later claimed, “We’re just the Geek Squad from Best Buy” taking orders from the state.

Before the trial court, the state sought the maximum it could recover from IBM – $125 million of the $437 million it paid during the first three years of its contract. IBM sought more than $100 million – claims it restated to the appeals panel during oral arguments.

“During the early part of the contract, IBM was being underpaid,” said IBM attorney Jay

Lefkowitz of the New York firm Kirkland & Ellis LLP. “… Our costs were going to be significantly more than $10 million a month” that the state was paying at the outset.

IBM’s efforts to upgrade the state’s computer systems for screening and processing claims for welfare, food stamps and Medicaid was “plagued with problems from the start,” Rusthoven told the Court of Appeals panel. He argued the judges would have to determine whether Dreyer’s opinion was “infected from top to bottom with legal errors,” beginning with the ruling that IBM was not in material breach.

Judge Nancy Vaidik countered Rusthoven’s assessment of IBM’s performance. The trial court made particular findings of fact, for instance, that “IBM was curing these problems” at the time the contract was nixed, Vaidik said.

Rusthoven said that was among the clear errors in the trial court ruling. He pointed to language in the IBM contract saying the state had to be satisfied with the company’s overall performance. He said the court had to look at IBM’s performance under the contract in totality. “The state was not satisfied in 2009,” he said.

apb-il-ibm02-15col.jpg Company attorney Jay Lefkowitz argues the state should pay more than $100 million for canceling its contract to upgrade Indiana’s welfare system. (IL Photo/Aaron P. Bernstein)

“You paid $437 million for something,” Judge Ezra Friedlander interjected. “You had to be satisfied with something.” Presiding Judge John Baker also pointed to the amount the state paid before canceling the contract and arguing breach.

Rusthoven said the state never argued that IBM did nothing, but rather that the company wasn’t hitting performance goals. And just because the state continued paying IBM roughly $10 million a month under the contract, “That doesn’t give (IBM) a blank ‘no-material-breach’ check,” he said.

Rusthoven answered Vaidik’s query of what he would have the court do by urging the panel to vacate the awards.

He also told the panel key IBM witnesses and the company’s internal documents showed that some of the claimed damages IBM sought under the contract were “arbitrary” and unenforceable.

But Lefkowitz dismissed testimony of “arbitrary” claims as coming from “a much more junior member of the team.” He said his client was entitled to sums in addition to those awarded by the trial court. Lefkowitz pushed for total damages of about $106.6 million.

That increased amount would include an additional $43 million in deferred fees – a “true-up” or “make-whole payment” reflecting the greater amount of upfront work IBM performed at the outset of the contract, plus compensation for lost revenue.

The trial court ruled the state failed to show IBM in material breach despite evidence of poor performance under the contract. The state also received benefits including improved FSSA performance as a result of the contract, a ruling the trial court also found precluded a determination of material breach.

The court’s $52 million in damages includes $40 million in assignment fees Indiana owes IBM because the state retained the company’s subcontractors after it dropped IBM. Another $9.5 million in equipment expenses was awarded to pay for computers, monitors, furniture and other assets procured under the contract, and an additional $2.5 million was awarded in early termination close-out payments. That includes actual costs to IBM that were incurred as a result of the state’s cancellation of the contract.

apb-il-ibm01-15col.jpg Presiding Court of Appeals Judge John Baker addresses a question to counsel in State v. IBM during oral arguments Nov. 25. Panelists flanking Baker are Judges Ezra Friedlander and Nancy Vaidik. (IL Photo/Aaron P. Bernstein)

Lefkowitz said the state received clear benefits from hiring the same subcontractors IBM lined up to do the work, and that when Gov. Mitch Daniels canceled the contract, IBM experienced a tangible loss that can only be compensated by the additional $43 million award. “We were going to make $4.7 million a year just from one of the subcontractors,” Lefkowitz told the panel.

The state is still using equipment provided under the IBM contract, according to Lefkowitz. “It makes perfect sense you’ve got to buy this equipment if you want to use it.”

Rusthoven countered to the panel that the argument for deferred fees would set a dangerous precedent. “IBM is claiming it had a right to make a loan to the state which the state now has to repay.”

While Rusthoven also argued the state has sovereign immunity from paying prejudgment interest, Lefkowitz disagreed, claiming “the state stands on the same footing as any other party.”

A day after oral arguments in State v. IBM, a separate appeals court panel affirmed Dreyer’s rulings in a suit IBM filed against a subcontractor, ACS Human Services Inc. That appeals panel upheld a ruling that IBM owed ACS $709,398.95 in costs related to discovery and costs of production of documents as a nonparty in the state suit. Also affirmed was the trial court’s grant to IBM of $425,178.85 in sanctions against ACS.

The Court of Appeals will rule in State v. IBM at a later date.•

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  1. He TIL team,please zap this comment too since it was merely marking a scammer and not reflecting on the story. Thanks, happy Monday, keep up the fine work.

  2. You just need my social security number sent to your Gmail account to process then loan, right? Beware scammers indeed.

  3. The appellate court just said doctors can be sued for reporting child abuse. The most dangerous form of child abuse with the highest mortality rate of any form of child abuse (between 6% and 9% according to the below listed studies). Now doctors will be far less likely to report this form of dangerous child abuse in Indiana. If you want to know what this is, google the names Lacey Spears, Julie Conley (and look at what happened when uninformed judges returned that child against medical advice), Hope Ybarra, and Dixie Blanchard. Here is some really good reporting on what this allegation was: http://media.star-telegram.com/Munchausenmoms/ Here are the two research papers: http://www.sciencedirect.com/science/article/pii/0145213487900810 http://www.sciencedirect.com/science/article/pii/S0145213403000309 25% of sibling are dead in that second study. 25%!!! Unbelievable ruling. Chilling. Wrong.

  4. Mr. Levin says that the BMV engaged in misconduct--that the BMV (or, rather, someone in the BMV) knew Indiana motorists were being overcharged fees but did nothing to correct the situation. Such misconduct, whether engaged in by one individual or by a group, is called theft (defined as knowingly or intentionally exerting unauthorized control over the property of another person with the intent to deprive the other person of the property's value or use). Theft is a crime in Indiana (as it still is in most of the civilized world). One wonders, then, why there have been no criminal prosecutions of BMV officials for this theft? Government misconduct doesn't occur in a vacuum. An individual who works for or oversees a government agency is responsible for the misconduct. In this instance, somebody (or somebodies) with the BMV, at some time, knew Indiana motorists were being overcharged. What's more, this person (or these people), even after having the error of their ways pointed out to them, did nothing to fix the problem. Instead, the overcharges continued. Thus, the taxpayers of Indiana are also on the hook for the millions of dollars in attorneys fees (for both sides; the BMV didn't see fit to avail itself of the services of a lawyer employed by the state government) that had to be spent in order to finally convince the BMV that stealing money from Indiana motorists was a bad thing. Given that the BMV official(s) responsible for this crime continued their misconduct, covered it up, and never did anything until the agency reached an agreeable settlement, it seems the statute of limitations for prosecuting these folks has not yet run. I hope our Attorney General is paying attention to this fiasco and is seriously considering prosecution. Indiana, the state that works . . . for thieves.

  5. I'm glad that attorney Carl Hayes, who represented the BMV in this case, is able to say that his client "is pleased to have resolved the issue". Everyone makes mistakes, even bureaucratic behemoths like Indiana's BMV. So to some extent we need to be forgiving of such mistakes. But when those mistakes are going to cost Indiana taxpayers millions of dollars to rectify (because neither plaintiff's counsel nor Mr. Hayes gave freely of their services, and the BMV, being a state-funded agency, relies on taxpayer dollars to pay these attorneys their fees), the agency doesn't have a right to feel "pleased to have resolved the issue". One is left wondering why the BMV feels so pleased with this resolution? The magnitude of the agency's overcharges might suggest to some that, perhaps, these errors were more than mere oversight. Could this be why the agency is so "pleased" with this resolution? Will Indiana motorists ever be assured that the culture of incompetence (if not worse) that the BMV seems to have fostered is no longer the status quo? Or will even more "overcharges" and lawsuits result? It's fairly obvious who is really "pleased to have resolved the issue", and it's not Indiana's taxpayers who are on the hook for the legal fees generated in these cases.

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