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State, IBM spar over damages during Supreme Court oral arguments

February 21, 2019

It’s been roughly nine years since a hard-fought legal battle over the creation of a new Hoosier welfare system ensued between the state of Indiana and IBM Corp.

Once already the case has gone up to the Indiana Supreme Court, which ruled on the issue of breach in 2016. Then on Thursday, the long-lasting litigation returned to the justices, who this time must answer a multi-million-dollar damages question.

Justices, excluding Justice Mark Massa, heard the case of International Business Machines Corporation v. State of Indiana, 19S-PL-00019, on Thursday morning. The court granted transfer after the Indiana Court of Appeals ruled in September that the state must pay post-judgment interest on $49.5 million in damages awarded to IBM in 2012. But the judges also upheld a $78 million judgment in favor of Indiana based on IBM’s breach of its contract with the state to develop the new welfare system.

At issue is the difference between two welfare systems, one implemented by IBM and the other implemented by the state. The system created by IBM, known colloquially as modernization, represented a shift toward a centralized call center that could handle customer requests. But when modernization experienced several issues and contract renegotiations between the parties broke down, the state took over the welfare revamp and terminated the contract in 2009. The new state-created system, known as hybrid, combined the call center with the prior model that emphasized face-to-face contact with customers.

The Marion Superior Court initially found that modernization’s failure was not a breach of IBM’s contract with the state and instead ordered the state to pay $49.5 million to IBM for the costs of equipment and assignment fees. But appellate courts, including the Supreme Court, found IBM had breached the contract and remanded the case for a damages assessment.

Judge Heather Welch awarded damages to the state totaling $128 million, offset by the $49.5 million owed to IBM, for a net damages award of $78 million. Welch also declined to award post-judgment interest to IBM on the $49.5 million, a decision the COA reversed after hearing oral arguments last August.

Both parties petitioned to transfer, with IBM arguing Thursday that the trial court erroneously allowed the state to recover $125 million specifically for the costs of implementing the hybrid system. The only hybrid-related costs the state can recover, its attorney said, are reprocurement costs, or the amount spent on any services IBM was contractually obligated to perform before the contract’s termination but did not perform. 

Paul Clement, a Washington, D.C.-based attorney who argued on behalf of IBM, said the company acknowledged its breach. However, Clement maintained that the services featured in hybrid were not considered under the original contract for the failed modernization system. Thus, IBM was not on the hook to pay the costs of implementing a welfare system it was never required to create.

But Barnes & Thornburg partner Peter Rusthoven, arguing on behalf of the state, said there was a reason the hybrid was substantially different than modernization – hybrid worked, while modernization did not. If the state had created a system that was similar to IBM’s modernization, it also would not have worked, Rusthoven said. Thus, Indiana had no choice but to do something different.

Further, Rusthoven argued the contract for modernization essentially required two things of IBM’s welfare system: compliance with federal law and assistance for poor Hoosiers. Modernization accomplished neither of those goals, he said, so the state was forced to take a different tack to make the new system work. What’s more, because modernization didn’t meet those goals, Rusthoven said IBM is responsible for the costs of the switch to hybrid.

For its part, the state focused its argument before the high court on the award of post-judgment interest. Rusthoven said no such interest was warranted because the 2016 ruling that found IBM breached the contract meant no final judgment had been entered in the case. The attorney acknowledged that both parties initially filed separate suits that were consolidated but rejected the argument that the consolidation affected the question of whether final judgment had been entered.

“They’re not separate cases,” Rusthoven told the justices. “It’s one case.”

The consolidation question put form over substance, Rusthoven continued. The substance of the case, he said, is a single contractual dispute, and the Supreme Court’s remand of the damages issue meant final judgment had not been entered in that dispute.

Clement, however, insisted the Court of Appeals was correct in awarding post-judgment interest. He noted the case went up on appeal with no question as to the final judgment issue and pointed out that the COA called the $49.5 million award “the one constant in this case… .”

The justices were relatively quiet throughout the arguments, though all four did ask at least one question of the attorneys. One issue Chief Justice Loretta Rush grappled with was whether the features of the hybrid system had been contemplated in the original contract that led to modernization.

Clement conceded that some features overlapped, but told the chief justice she was asking the wrong question. The right question, he said, is if IBM was contractually obligated to create the hybrid system before its contract with the state was terminated.

The answer is “no,” Clement said, noting that Rusthoven had admitted hybrid was substantially different than modernization. But contrary to Rusthoven’s insistence that the state’s product had to be different than IBM’s failed product, Clement said the differences between the two welfare systems represent a decision by the state to move in a different direction than what was contemplated by the initial contract. If that’s the case, Clement said, then IBM is not on the hook for the costs of implementing the new system.

Massa did not participate in Thursday’s argument because he previously worked for former Gov. Mitch Daniels, who contracted with IBM to create a new welfare system for the state.

The full oral arguments in the case can be viewed here.

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