Germany: Outsourcing With No Exit? How To Avoid A Lock-In

Last Updated: 22 March 2012
Article by Dr. Marc Hilber, LL.M.

Just like in our own personal life: when you enter into a relationship you naturally don't spare a thought about how it's going to turn out in the end. However, not giving the necessary due attention where outsourcing contracts are concerned can have dire consequences. Once the contract has expired there are various reasons why it can be difficult to change a provider or re-convert the services back into your own company operations again, i.e. the so-called lock-in effect can have very negative consequences. For this reason, exit scenarios should be taken into consideration from the outset when selecting a service provider and structuring the contract.

Flexible in long-term contracts

Service providers frequently insist on lengthy contractual terms so that they can amortise their initial investments, e.g. the costs for assuming the expensive structures already being deployed by the customer. Although the statutory right to terminate for cause ("wichtiger Grund") cannot be contracted out, the customer will have no right to terminate the contract as long as the service provider is rendering the contractual services in a fit and proper manner. Outsourcing contracts generally also contain exclusivity clauses or provide for minimum volumes which prevent the customer from hiring another service provider in parallel thereto. Although such clauses can be invalid under antitrust law as they restrict free competition, as a rule it is only in respect of contracts with a term of five years or more and where the service provider has got a strong position in the market that such a threat could become a reality.

As the commitment will be a long-term one, it is crucial that price adjustment clauses and change-of-management provisions allowing for the implementation of desired changes in the services are put in place in advance. Price adjustment rights and a pertinent modification procedure are thus key elements and frequently a bone of contention. The challenge facing the customer is to anticipate expected future developments and to account for these in a manner that is acceptable to both sides. In addition, the parties have to comply with the German Price Clause Act [Preisklauselgesetz, PreisKlG], which permits automatic price adjustments only under certain circumstances.

Separation after expiry is difficult

Even when an outsourcing contract runs its normal course through termination or expiry of the agreed contractual term, it can be difficult to detach oneself from the service provider. It is in any case only if the particular services are no longer required that a contract may freely be allowed to elapse. As a rule, however, the services will still be required, but they will either have to be transferred to another service provider or be re-absorbed into the customer's own business. Difficulties can nevertheless still arise for various reasons irrespective of which of the two routes one finally decides to go down.

Minimum volumes or exclusivity, for example, are commonly agreed upon in order to secure the service provider's business. In cases of this kind, however, where a contract is terminated or expires, the customer may not simply transfer the services to a third party or even assume such services itself successively (staged phase out); the customer is rather required to undertake this in a single action. It is for this reason in particular that a successive reduction of the services should be expressly permitted during the exit phase leading up to the end of the contractual term. This could even be of advantage to the service provider as well because it would enable the provider to restructure and/or re-allocate its resources gradually by degrees. Thus, precise planning and cooperation are required if an exit is planned. On the customer's side, any new service provider should also be involved in the exercise.

The length of the exit phase can vary greatly depending on the complexity of the services. Where complex services that are not standardized and not customarily found on the market are concerned, this transition phase can take up to one year or even longer in practice. An extraordinary termination for cause (which likewise cannot be contracted out) will also give rise to difficulties: Even if the service provider should give notice of termination with immediate effect, one could not seriously expect the customer to accept being left virtually overnight without services of vital importance to its business operations. For this reason, outsourcing contracts generally provide for a mandatory transitional exit period which likewise also has to be observed if the service provider gives immediate notice of termination. If the service provider terminates a contract without notice because of payment arrears, the outsourcing agreement may stipulate that services will only be rendered during the transitional phase once payment of the disputed amounts has been credited to a trust account.

Individuality makes separation more difficult

The transfer of services to another provider could also fail because the services have been tailored especially to the needs of a particular customer. A third party might therefore not have the specific know-how required to render the services in question. A re-integration of the services at the customer itself could also fail because the customer would then no longer be in possession of the required know-how in the outsourced area. Therefore, in a first step, customers should ensure that key personnel remain with the enterprise – also for the purpose of supervising the service provider. As a second step, documenting the know-how is particularly important, e.g. in the form of describing the processes. From the customer's point of view, the service provider should be obliged to provide reasonable documentation at the beginning of the transitional exit phase. However, since it is rarely possible to prepare documentation shortly before the impending expiration of a contract, it is advisable where complex services are concerned to have documentation provided from the beginning of the contract and for this documentation to be kept up to date on a constant basis (unless the service specification is already process-based (and not result-based).

It is also advisable to tackle the question of the migration of data held by the service provider to the new system in good time and to have the pertinent procedure fixed in the contract. IT-supported data processing also plays an important role where the outsourcing of business processes like stock keeping or purchasing are concerned. Here, too, the service provider is in possession of important data that will need to be re-transferred to the customer by the end of the contract at the latest. Above all, any rules on data formats and precise processes that are unclear or which may have been omitted can create problems in this connection.

In an ideal case the service provider will provide the data in the agreed quality and appropriate format at the agreed times (as early as possible). This would enable the customer to conduct the data migration during the transitional exit phase (and, where applicable, also in conjunction with the new service provider) and thus prepare for and ensure the seamless transfer of responsibility for the services at the end of the contract. To take an example: If a CRM system has been moved into the cloud and the customer database is to be re-integrated or transferred to a new service provider, careful migration planning is required in order to ensure a continuous line of customer service and to avoid data being lost.

Beware of poison pills

The migration of data will be even more difficult if a new service provider cannot easily be found or if, for example, such provider needs to use the software customized by the previous service provider. In a case like this and in as far as the customer is concerned, the previous service provider should be obliged to legally transfer the software rights, even if they have been further developed by the latter within the scope of the outsourcing services.

So-called poison pills, like the obligation to buy back worthless or excessively over priced assets, are detrimental to a successful exit from outsourcing services or a change of outsourcer. Above all, such re-transfer of assets could constitute a transfer of business which would result in employees transferring to the new service provider or, in the case of a re-integration, to the customer itself. In contrast, where outsourcing into the cloud is concerned, as a rule, no dedicated assets exist. In this case, operation, hardware and software would have to be obtained from other sources.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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