Don’t Skip on the Details | Article

Structuring and Documenting the Real Content of Outsourcing Agreements

curve in road signMost outsourcing agreements are complex services arrangements that typically involve the transfer of various assets and factors of production, including relevant personnel, to the outsourcing supplier, and the sale back to the customer, on a long-term basis, of certain services that are critical to the support of the customer’s business.

The documentation of such an undertaking should act as a road map to guide the implementation of the arrangement and to enhance the likelihood that the often differing goals of both customer and supplier will be attained.

In the majority of outsourcing agreements, a significant proportion of the details are set out in the exhibits (or schedules) to the main agreement (or T&Cs). Indeed, the exhibits will contain, at a minimum, a description of the services to be provided by the supplier and the fees to be paid by the customer — i.e., the guts of the deal.

The challenge to fully document these exhibits and other related aspects of the transaction can often be the defining factor between a successful outsourcing arrangement and a deal gone bad.

Incomplete documentation of the supplier’s service obligations can result in customer dissatisfaction when the customer doesn’t get what it expects. Inaccurate categorization of the service volumes and charges can result in disputes over payment as subsequent changes translate into additional costs for the customer or extra expenses for the supplier.

Consequently, whether structuring and documenting a large-scale information technology (IT) outsourcing contract or a limited-scope business process outsourcing (BPO) arrangement, it is important to devote adequate resources, including business, legal, subject matter expert and, if available, documentation specialist personnel, to the development, negotiation and review of the occasionally neglected, but always important, exhibits.

Spell Out the Content

In a typical outsourcing transaction, the details found in the exhibits include:

  • The definition of the scope of the services to be provided to the customer.
  • The specification of the performance standards that will be used to gauge the supplier’s performance.
  • A delineation of the pricing structure, including procedures for adjusting fees.
  • A description of the process and milestones to be used to transition existing services from customer to supplier.
  • A statement of the terms governing the selection, hiring and transfer of the customer’s personnel to the supplier.

While the documentation of these and other related details may not appear to require the same rigor as is customarily applied to the more obvious “legal” provisions in the T&Cs, the exhibits set out numerous important obligations. Complete and accurate content in the exhibits is integral to the successful operation of the relationship between the customer and the supplier. Placing sufficient focus on the exhibits early and consistently throughout the transaction cycle will allow the parties time to negotiate and document appropriate terms and ensure the consistency of the exhibits with the T&Cs.

Draft in the Right Language

A supplier will typically advocate that the customer use the supplier’s templates when developing exhibits. While these templates may simplify the drafting process, they will generally contain language and “legalese” preferred by the supplier. A law firm or consultant experienced in working for outsourcing customers can bring added value by providing a package of customer-oriented exhibit templates and sample documents for the customer to utilize. No matter what templates are used, it is imperative that they be properly customized to fit the requirements and content of the particular deal.

Consider the statement of work exhibit, which will describe the services to be provided by the supplier. Unless already developed as part of a relevant RFP process, the customer will need to determine whether to adapt the supplier’s template or to develop its own statement of work. The supplier’s template will likely contain much of the base description of the services to be provided, but it will probably also contain various assumptions or conditions with respect to the supplier’s performance of the services that will need to be carefully reviewed and worked through during negotiations.

The customer must also decide whether the statement of work will be a detailed description of each supplier activity or a general listing of activity categories with appropriate references to existing customer or supplier documentation that provide the required detail. While a high-level statement of work may cut down on the drafting, the time spent accurately referencing and reviewing the appropriate documents to ensure that they contain the required detail may prove to be overly time consuming.

When dealing with templates, as with any document-intensive deal, it is best to agree beforehand on which party will draft each exhibit. Even in situations where redlined drafts of an exhibit will be exchanged electronically between supplier and customer, it is wise for one party to be responsible for inputting any agreed upon changes to the master documents and for maintaining version control.

Certainly, some exhibits can be created fairly quickly without a template or even plucked from an existing database. When crafting exhibits, such as lists of the supplier and customer sites involved in the delivery and receipt of services, the assets to be transferred or the reports to be produced by the supplier, it is usually sufficient that these details are spelled out in readable form and attached to an exhibit cover page.

That said, whether the exhibit is a newly-drafted statement of work or an existing spreadsheet of company data, the content should be closely reviewed with the respective business, technical and legal team members to ensure the exhibits accurately document the transaction.

Specify Formulas and Metrics

The service level and pricing exhibits, in particular, pose additional drafting issues. The service level exhibit establishes the performance criteria for the services and contains specific targets, or metrics, that will be used to evaluate performance. The exhibit may also include additional service level benchmarks used to receive credits from or award bonuses to the supplier. Taking the time to specifically describe the performance expectations and resulting impact will provide an increased level of control over the outsourcing relationship.

For instance, in a BPO transaction for tax compliance processing, the parties may agree that the supplier will incur credits if it delivers the tax returns to the customer in less than a certain number of days prior to the applicable filing date and/or accrue bonuses if the returns are delivered well in advance of that date. More than simply stating this credit and bonus plan, the exhibit should specify the methodology used to calculate the applicable credits or bonuses and explain how the credits or bonuses will be applied (e.g., in “hard” currency such as payment of fixed amounts or in “soft” currency such as earnbacks on future services.

Before specifying particular targets and any associated credits or bonuses, the parties should be confident that the targets can be accurately measured. For example, in an IT outsourcing transaction for data processing services, the service level exhibit may identify a system response time. The measurement of that response time may include the time it takes for the data to travel through a network controlled by the customer or a third party. Failure to agree upon and document the methodology on how to measure the response time in such circumstances may cause difficulties in determining whether the supplier has met the service level in the event problems occur in the network. To further reduce the likelihood of disputes, it may be useful to include examples of the calculations.

Although the customer and the supplier should strive to agree on and document targets that can be benchmarked using historical data, other options exist. The parties may alternatively agree upon a limited verification period once the supplier begins delivering the services, during which time service levels can be established. In such a case, document in the exhibit the parameters for the verification period and explain how the service levels will later be determined. Reaching an agreement on these matters after the contract has been signed may prove more elusive.

Like service level exhibits, the pricing exhibit generally calls for an additional degree of detail. The pricing exhibit sets out the base charges, identifies the categories of resources, defines the individual resource units and specifies rates on which the fee calculations are based. The exhibit will also include an explanation of how incremental charges or deductions for additional or reduced services will be applied and how cost-of-living increases may (or may not) effect the pricing structure. Depending upon the complexity of the transaction and the pricing methodology, sample calculations of the fees can be included to show how a particular pricing formula works.

Overall, the pricing and service level exhibits should illustrate a correlation back to the statement of work so that each party can readily determine what services are provided at what level and for what cost. The parties can expect extensive negotiation over the application and documentation of formulas and metrics to be utilized. Careful review of these exhibits by the business, technical and legal team members will help ensure that the mechanisms reflect the parties’ intentions, saving headaches for those charged with implementing them.

Pinpoint Transition Procedures

Most of the provisions governing the cut-over of the services from the customer to the supplier are set out in the exhibits. Usually, there is one exhibit documenting how the existing services are to be transitioned to the supplier and another documenting how the customer’s personnel are to be transferred to the supplier. In each case, early involvement of the parties’ respective operational, human resource and legal teams is vital to the drafting of such exhibits.

The transition services exhibit typically includes a breakdown of transition team responsibilities with respect to planning and implementing the transition. It may also include milestones by which transition activities must be completed to avoid deferment of fees by the customer.

The personnel transfer exhibit focuses on the terms and conditions governing the supplier’s interviewing and hiring of those customer employees currently performing the services to be transitioned, as well as rules governing salaries and the effect and transfer of earned benefits. Where applicable, it also includes guidelines for the customer’s rehiring of those employees at the expiration or termination of the agreement.

There is often a third, related transfer exhibit documenting how the services, as well as any related equipment, facilities, materials and licensing rights, are to be transitioned back to the customer (or to a third party) at the expiration or termination of the agreement.

Other exhibits relating to the ongoing operation of the services generally require less extensive drafting, often because the exhibits reference other documents. These include exhibits on the organizational and management structure of the relationship, the policies and procedures governing how the parties will interact, and the customer’s security requirements and procedures.

Nonetheless, incorporation by reference only works if the referenced documents contain the required information, and early review of the applicable organizational, procedural and security documents by both parties is worthwhile.

Reward for Your Efforts

To lessen the likelihood of a deal unraveling or spurring costly disputes, the development, negotiation and documentation of the exhibits to an outsourcing transaction should never be shortchanged. The exhibits generally contain extensive details and related terms and conditions that are germane to the proper functioning of any such arrangement – thereby creating significant legal obligations for the parties – and require as much diligence and attention by the legal and various commercial teams as do the T&Cs.

Too often, problems and disputes arise not from disagreements over the wording in the T&Cs but from incomplete or vague content in the exhibits. If the outsourcing team members give appropriate focus to the exhibits, more than perhaps is traditionally the case, then the documentation of the deal will be improved, the contract will be more complete and the outsourcing relationship will run more smoothly.

Lessons from the Outsourcing Journal:

  • The exhibits contain a description of the services to be provided by the supplier and the fees to be paid by the customer — the guts of the deal.
  • Documenting the exhibits can be the determining factor in the success of an outsourcing deal.
  • Be sure you are clear in the service level and price descriptions.

Greg Short is a counsel in Shaw Pittman’s Los Angeles office, where he handles a variety of technology transactions for suppliers and customers. He can be reached at 310 551 4524 or [email protected].


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