California has terminated its contract with SAP in connection with a $371 million software system that was supposed to overhaul the state's payroll system but instead ended up mired in major delays and cost overruns.

Some $254 million has already been spent on the project, which has now been placed on hold while state officials conduct an assessment to determine whether "any of SAP's work" can be used as part of an ultimate solution, according to a statement from Controller John Chiang.

SAP came onto the MyCalPAYS project in 2010, after the state fired the original contractor, BearingPoint. The first of five phases went live last June but "revealed a significant volume of troubling errors," according to the controller. "Eight months of payroll runs have yet to produce one pay cycle without material errors and have instead exposed a system riddled with grave weaknesses."

The initial phase targeted the controller's office, which includes just 1,300 employees out of the 240,000 working for the state, and their payroll requirements "are the easiest in the state," said Jacob Roper, a spokesman for Chiang. "We're calling it quits at the end of phase one."

"SAP is extremely disappointed in the [controller's] actions," spokesman Andy Kendzie said in a statement. "SAP stands behind our software and actions. Our products are functioning in thousands of government agencies around the world. SAP also believes we have satisfied all contractual obligations in this project."

SAP has also "made every reasonable attempt" to work with the controller's office and also sent a letter asking that the two sides enter mediation, but the state responded with the termination letter, according to Kendzie.

Chiang's office had sent "cure letters" to SAP ordering it to fix the project's issues on two separate occasions, Roper said.

The state has paid SAP $50 million so far, and is withholding about $7 million in additional payments, according to Roper. The rest of the project's price tag so far is made up of software licenses, staff time and other costs, he said.

Chiang's office "will pursue every contractual and legal option available to hold SAP accountable for its failed performance and to protect the interests of the State and its taxpayers," according to the statement released Friday. "This includes contractually required mediation and, if necessary, litigation."

The controllers office is planning to return its payroll operations back to the legacy system "that is currently and reliably paying all other 240,000 State employees," the statement adds.

MyCalPAYS is the "largest payroll modernization effort" in the nation, according to Chiang's office.

It would be a mistake to take California's version of events at face value, according to one observer.

"There are one of two possibilities here, the data getting into the system is wrong, or the system itself is taking correct data and mangling it," said Michael Krigsman, CEO of consulting firm Asuret. "Despite SAP's history with project failures, SAP has many other government customers using payroll successfully. In this case, it's just not likely that SAP would not be able to handle a fairly simple payroll for 1,300 people."

In addition, "you have to assume that after going back and forth [with the state], SAP must have put good people on it to troubleshoot [the project]," added Krigsman.

California also has a history of large IT project failures, which "further casts questions onto the role of the state controller's office in this," Krigsman added. "I wonder what sort of skeletons lie in the [controller's] data closet that could have contributed to this problem."

Chris Kanaracus covers enterprise software and general technology breaking news for The IDG News Service. Chris' email address is Chris_Kanaracus@idg.com