When you are an outsourcing customer, exit provisions are among the most valuable contractual protections. They are vital for allowing your business to continue through the termination of an outsourcing relationship and providing leverage in re-negotiations. Moreover, unlike most provisions in an outsourcing contract, the exit provisions likely will be used in situations where your relationship with your service provider is so strained that your service provider is only doing the minimum required to comply with the contract.
The key to getting the right exit provisions is asking yourself these seven questions:
1. Why will you want to terminate?
Most outsourcing agreements permit termination “for cause,” that is, upon a material breach that is not cured within a specified period. Others, better negotiated, permit termination “for convenience” (that is, without cause) but for a substantial price. That price is referred to as a “termination for convenience fee.”
What customers are often missing is a right to terminate without paying a termination for convenience fee when the service provider is meeting its contractual obligations but failing in some larger way. For example, the service provider might be:
- Going out of business (Arthur Andersen),
- Failing to meet financial covenants (Worldcom),
- Bankrupt (Enron and too many dot-coms),
- Incapacitated by a force majeure event (think Wipro or Tata if India goes to war with Pakistan), or
- Unable to keep pace with its own or the customer’s market.
By considering all the instances where you may want to terminate, you can include provisions in the contract that give you the exit rights you need. These termination provisions require thought because they may be unique to your business and because you cannot expect to find them in a service provider’s form contract or even in most customer-friendly form contracts.
2. What termination rights will you give your service provider?
Outsourcing is a dependent relationship. Transitioning away from a service provider involves considerable cost, risk and disruption. For this reason, smart customers sharply restrict the service provider’s right to terminate. For example, the service provider might have the right to terminate only upon a sustained failure to pay undisputed amounts.
3. What will you do when the contract terminates?
A well-considered termination plan allows you to identify what you will need in order to make a successful transition. Ideally, you would begin this effort before you outsource because you have the information required to source the service and the people who know how to run it. After you outsource, both of those resources may be in the service provider’s hands.
4. What will you need from your service provider to make a smooth transition?
If you have a clear plan for what to do upon termination, you can identify precisely the termination assistance you will need from your service provider. That might include, for example:
- Transition planning assistance;
- Inventories of equipment, software and other assets that the service provider uses to provide the services;
- Copies of data, procedures, error logs, documentation and other information that the service provider generates as a part of providing the services (along with the right to provide this information to potential successor service providers);
- The right to hire the people, buy the assets, license the software and assume the subcontracts used by service provider to provide the services;
- Consulting services in connection with the transition;
- Parallel processing for some period, with the right to extend the term as necessary to resolve issues before the final cutover to the new service provider or your own internal personnel, and
- Continued use of shared networks or other similar assets after the transition is complete.
Unless your crystal ball is exceptionally clear, you should also include general clauses, such as “Service provider shall provide such termination assistance as reasonably requested by Customer.” These can help fill gaps, though the service provider may take the general nature of the provision as an excuse to exclude the help that you particularly need.
5. How will you give the service provider incentives to provide termination assistance?
With luck, your jilted service provider will decide to provide high quality service until the end of the outsourcing arrangement. Unfortunately, some service providers have hard feelings about a termination or decide to focus their energies on serving their continuing customers instead of their departing customers. As a result, you can’t rely on the “relationship” to provide motivation.
You can, however, build both carrots and sticks into the contract. The most common carrot is substantial fees for providing termination assistance services. Similarly, consider paying any termination fee only upon successful completion of the transition. For sticks, consider providing for injunctive relief or exempting damages you incur as a result of your service provider’s failure to provide termination assistance services from any limitation of liability. Each of these carrots and sticks helps to motivate a capable service provider to do its best.
6. Can you “build for exit”?
These days, many customers have found themselves wishing they were dealing with a capable but poorly motivated service provider. Some service providers have imploded, leaving no one to provide transition services. Others are in bankruptcy, where “executory obligations” (such as obligations to provide termination assistance) allowing them to avoid or stay any claims. Some service providers are still afloat but are circling the drain so fast that they cannot properly focus on providing termination assistance.
You may be able to reduce this risk by structuring the deal to allow an easy exit without termination assistance. A contract that is “built for exit” might require the service provider to:
- Continue to use facilities, software, equipment and subcontractors that you own or have a right to use;
- Provide you with traditionally internal information, such as the home phone numbers of any key personnel;
- Implement a mirrored disaster recovery site for your work specifically and a disaster recovery plan that you could implement if the service provider’s facility were to be destroyed, and
- Cooperate with you in building internal capability or outside relationships to provide the same services that the outsourcer provides.
Each of these alternatives, however, means losing some of the economic benefits of outsourcing. Making the service provider use your facilities and technology means losing the benefit of the provider’s presumably superior technology. Breaking your work out from the rest of the provider’s work or breaking your work into separate pieces means losing of the economies of scale.
7. Could you use early termination assistance to reduce risk?
If a built-for-exit contract is uneconomic, get the right to obtain key termination services before giving a termination notice. For example, the contract could require the service provider to develop and maintain a procedures manual detailing how the services will be performed. In addition to being a useful outsourcing management tool, a procedures manual can be the basis for an RFP for a successor service provider or a template for building an internal capability. Other examples include provisions for operational and technical audits, control over changes in technology, rights to regular data downloads, source code escrows, and close management of services.
Lessons from the Outsourcing Journal:
- Smart customers think the termination through before they sign the contract.
- A good outsourcing contract includes specific rights to termination assistance as required for a smooth transition.
- The deeper you go into an outsourcing relationship, the more difficult it is to exit. You can reduce risk by retaining control over critical technologies and by preserving your alternatives.
Attorney Brad L. Peterson is a partner in the 50-lawyer IT and Outsourcing Practice at Mayer, Brown, Rowe & Maw in Chicago. He is the co-author of The Smart Way to Buy Information Technology: How to Maximize Value and Avoid Costly Pitfalls (AMACOM Books, 1998). You can reach him at [email protected].