COA upholds $78 million for state in IBM suit, awards IBM interest

The Indiana Court of Appeals has upheld a $78 million judgment in favor of the state and against IBM Corp. that was awarded as part of a long-running legal battle stemming from IBM’s breach of a contract to redesign the state’s welfare system in 2006. But the court also ordered the state to pay post-judgment interest to IBM on a $49.5 million damages award it previously received, overturning a lower court ruling on that issue.

Friday’s decision in International Business Machines Corporation v. State of Indiana, acting on behalf of the Indiana Family & Social Services Administration, 49A02-1709-PL-2006, marks just the latest chapter in a “seemingly never-ending saga” that has already been through the entire appellate process once and is now being reconsidered on appeal after a Supreme Court remand. Both parties sued each other in 2010 after the state terminated a master services agreement it had signed with IBM, which was tasked with developing a new claims-processing system for the state.

The original IBM product, known colloquially as modernization, was launched in 2006 and represented a shift toward a centralized call center that could handle customer requests. But after a series of issues with modernization, the state terminated the contract and instead implemented a new system, known as hybrid, in 2009. As the name implies, the hybrid model combined the call center with the prior model that emphasized face-to-face contact with customers.

The case was originally assigned to Marion Superior Judge David Dreyer, who found IBM had not breached the agreement through modernization’s failure and awarded the company $49.5 million in damages. The Indiana Supreme Court reversed on the issue of breach and remanded the case to the trial court for a calculation of damages.
The case was eventually reassigned to Judge Heather Welch, who ordered IBM to pay $78.2 million to the state. But Welch declined to award post-judgment interest to IBM, a decision that became one of two major issues in the August oral argument before the Indiana Court of Appeals.

Specifically, Washington, DC.-based attorney Paul Clement argued on behalf of IBM that because the $49.5 million damages award was never overturned during the appellate process, the company was entitled to post-judgment interest on the unpaid award dating back to 2012. Clement also said Welch erred in ordering the $78 million damages award, arguing IBM should not be responsible for paying the costs the state incurred by implementing hybrid.

Writing for a unanimous appellate panel, Judge Patricia Riley disagreed with IBM on the latter point, finding first that Welch did not err in setting aside Dreyer’s findings when calculating damages. Riley then upheld the $78 million damages award, finding IBM promised some of the features found in the hybrid model when it initially pitched the failed modernization model.

“Accordingly, we conclude that Hybrid fits the scope, objectives, and requirements of the MSA and implements a working version of Modernization,” Riley wrote, echoing the state’s argument that the only difference between the two systems was that hybrid worked. “Therefore, costs incurred to implement Hybrid are recoverable as damages due to IBM’s material breach of the MSA.”

But the panel did agree to award post-judgment interest to IBM, noting that “the one constant in this case has been IBM’s award of assignment and equipment fees upon IBM’s Complaint against the State.”

“Although the State challenged those awards on appeal, both this court and the supreme court expressly affirmed that portion of the judgment on the combined Complaints,” Riley wrote, remanding the case for calculation of post-judgment interest dating back to July 18, 2012.

Finally, the appellate panel rejected both of the state’s cross-appeals, finding Welch properly set the direct damages cap of the MSA at $125 million and properly denied the state’s request for an additional $36.5 million to cover the salaries of 98 new state employees hired in response to modernization’s shortcomings. 

“As these new positions did not exist under Modernization, their costs cannot constitute a ‘differential’ between the fees paid under the MSA and the replacement cost,” Riley said.

Barnes & Thornburg attorneys John Maley and Peter Rusthoven, who represent the state in this litigation, praised the ruling in a statement. “We are pleased that the Court of Appeals affirmed Judge Welch’s findings that IBM caused $128 million in damages to the State, resulting in a net judgment to the State of $78 million after the $49 million offset, with interest running at 8 percent on that award since August of 2017. This is a significant victory for Hoosier taxpayers. We are reviewing the aspect of the ruling that IBM should receive interest on the offset.”