An outsourcing is likely to be one of the most complicated commercial deals that a company will enter into. Like any transaction, it needs legal documentation that is accurate and useable, clearly setting out each party's rights, obligations and protections. However, perhaps more than most other deals, an outsourcing makes heavy demands on a contract.
The challenge
Lawyering outsourcing deals is expensive and a good contract is a considerable investment. However, companies on both sides of the outsourcing relationship are often dissatisfied with the return they get. Projects fail leaving parties without useable protections. All too often negotiations sour relationships, even helping to bring about the very events the contract seeks to protect against.
These observations are not held uniquely by any one set of lawyers or consultants. There is an emerging consensus that by looking for a contractual center ground and using this to at least inform and hopefully influence the first draft, we can improve the negotiating process and the success rate of deals.
Why are outsourcing contracts different?
When a customer outsources a function, it gives up direct control and replaces this with rule by contract. Previously it could rely on many different levels of management, some obvious, others more subtle. There were no issues of enforceability, limitation of liability or whether the service or interdependency at issue had been fully documented. Once an outsourcing takes place, the only guaranteed control a customer has is through the contract and all of these factors and more become crucially important.
Added to this, while an outsourcing is costly to implement, getting out can be very difficult. IT systems and human resources are notoriously difficult to bring back in-house. Switching suppliers can be a painful process. The customer needs to find a way to live with the powerful forces of supplier dependency.
Successful outsourcing requires a special mindset. Other contracts record a moment in time - after an M&A deal, the parties typically go separate ways and there may be a 'winner' and a 'loser'. Outsourcing is more similar to a marriage. If it works the parties will have a long and intimate relationship. The contract's first job is to act as a framework for this. Like a marriage it must be flexible and allow each side to change. But like a marriage things can be very expensive and painful if the relationship does not work out.
Finally, the business dynamics of outsourcing change the emphasis of the legal documentation. While a customer needs a fully defined service specification, the supplier must be given scope to perform. Giving the customer sufficient protection while allowing this flexibility is a challenging balance.
A good contract is only a starting point
Unlike most other areas of contracting, the way that a deal is reached and not just the terms eventually agreed, has a significant impact on the chances of long term success. Very often the most difficult issues are those where traditional contract law does not give a ready answer. Flexibility and change are difficult concepts to fit into a contract. There is no simple legal provision that gives a clear answer as to how the risk of 'known unknowns' can be shared. The economic models that drive outsourcing often need 'fairness' - for the customer getting best value, for the supplier making a proper return. For lawyers, this can lead to an uncomfortable lack of contractual certainty.
Good contracts will have mechanisms to deal with these issues. However, these typically require a good relationship and mutual trust to work well (or at all). Ideally, the contract negotiation is the place where the parties build trust. All too often it is the battleground where trust is eroded. If a negotiation starts from an unrealistically imbalanced draft or one side is looking for 'victory', the parties are not incentivised to work together.
What do we need from outsourcing contracts?
Some practitioners have drawn false comfort from the feeling that 'no-one sues on an outsourcing contract'. With Cable & Wireless v IBM, Vertex v Powergen and Sears' action against CSC in the USA, the market is showing an increased appetite for litigation. Outsourcing lawyers are starting to gain their very own body of precedent law.
A deal where one party has managed to get the strongest legal terms possible is rarely a good one. It is important to capture both the letter and spirit of the transaction. If a customer forces unduly harsh terms on a supplier, there is usually plenty of scope for the supplier to use contract change provisions to reclaim lost ground. If the customer prevents the supplier making a fair return, it will not invest or prioritise the agreement.
The contract is a key element in a good deal. A good understanding of the emerging center ground on key issues terms can save considerable time and gain a lot of good will. Outsourcing has not yet attracted standard form documents in the way that construction projects have. Indeed it is probably too broad a church for standards to be meaningful. However, recognising a center position is a useful starting point. It can serve as a measure to judge whether a draft favours one side. At the least, by understanding the center, a party is forewarned and able to anticipate likely objections from the other.
Conclusion
The outsourcing industry has a lot to gain from understanding the center ground in key areas. These would benefit from a more balanced starting point than is sometimes used. A center ground is emerging and will continue to do so with time and after debate between advisors. With a recognition that each side must have protections for its legitimate interests, the central areas of a contract are likely to move towards more common starting positions.
We see the key areas for this process as the parameters of the service definition, performance regimes, termination for convenience, compliance with law, change management, IP use post termination and value control. We will look at these in subsequent articles.
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