UK: Renegotiating Outsource Agreements

Last Updated: 2 August 2006
Article by Simon Shooter

With the current increase in the number of outsource agreements being renegotiated, it is appropriate to look at some of the important factors that need to be taken into account before joining the renegotiation bandwagon. The customer's bargaining power is often significantly reduced in renegotiation as opposed to the negotiation of a fresh contract. This article considers some of the ways of seeking to level the playing field.

While nobody would question the fact that outsourcing is here to stay as a style of contracting, many that have been burned by outsource arrangements that have gone wrong are presently looking to escape from unhappy relationships with their suppliers or to renegotiate their outsourcing arrangements.

In the insurance sector, it is possible that the effect of the FSA’s common sense guidance in SYSC 3 has operated as a spur for customers to audit the performance of ongoing outsourcing and this may be a factor that has given rise to an increase in the number of insurance sector outsourcing arrangements currently under renegotiation.

Adjustments during the term of the agreement - the contract tools Well-drafted outsource contracts should have the tools for audit reviews built into them. Benchmarking clauses, service improvement planning, annual review meetings, steering committees and other similar devices are all used to provide methods for customers to monitor the performance and price of the arrangements that they have signed up to.

Access to information

A pre-requisite for any review is the availability of accurate and pertinent data. Clearly, if the contract contains provisions for the creation of management information and other such performance reports, the necessary facts should be readily available for review. Even if such requirements have not been provided for, it is common for contracts to include more general rights of audit that should provide a right to access the information that would be needed for such a review.

The forum for review

If there is a provision in the contract for an annual review that would usually be the appropriate forum to raise the outcome of the audit of performance and pricing data. Of course, it is not necessary for there to be such a provision as it is always open for a customer to call for a performance and pricing review without the need for contract terms.

Benchmarking

If such a "soft" forum does not bring about the desired aim then the customer may consider (if it is available) operating a benchmarking clause. This will provide a contractual mechanism, usually for an independent benchmarker to carry out a comparative review in order to provide an opinion on whether performance meets the standard that should be expected of the comparison group or whether the price is competitive by reference again to a comparison group. Benchmarking can be a very useful tool to police the technology and savings clauses as the benchmarker can test a supplier’s performance in driving down cost or implementing new technology against that supplier’s peer group.

Key to effective benchmarking clauses are the provisions that apply in the event the benchmark identifies a discrepancy in performance or price. The absence of a clear mechanism to address the results of benchmarking can lead the parties into dispute as seen in Cable & Wireless plc v IBM UK Ltd (2002). While there are no prescribed ways to deal with the response to a poor benchmark report, it is suggested that an equitable route is to provide for a period of time within which the performance deficiency must be remedied and/or the pricing is brought into line with the peer group average. If the supplier fails to comply with the requirement within the allotted time, the customer should be entitled to terminate the agreement.

The advantages of the soft forum and benchmark options outlined are that they are methods that are designed to operate within the term of the agreement and which should not threaten the relationship and necessarily give rise to a termination.

Come to our way of thinking or we Terminate
The alternative to the soft forum and benchmark options is to threaten termination. However, that tends to raise the stakes in terms of emotion and can start the negotiation off on a bad foot.

Break clauses

Some contracts will have break clauses that entitle parties to bring an arrangement to an early conclusion. The threat to operate the right to break is often used to gain leverage in negotiations on the grounds that there need to be certain changes in the way the contract is being performed or the services are being priced or the contract will be terminated.

Supplier breach

In the absence of a break clause it is often the case that the supplier’s conduct is put under a microscope to establish if there has been a breach or series of breaches that can be relied upon to permit termination. Usually the right to terminate will be dependent upon the breach being material (indeed the decision in Peregrine Systems Ltd v Steria Ltd (2005) requires the breach to be repudiatory) and the supplier failing to remedy the breach within a contractually agreed remedy period.

Gaining parity of bargaining power in Renegotiation

A customer’s bargaining power is at its greatest when a supplier is negotiating in competition with other potential suppliers for the award of a contract. Once the contract is underway the boot, to a degree, is on the other foot and the customer’s bargaining power is significantly reduced. While customers often use the threat of termination to seek to recover negotiating leverage, caution is advised. Termination may be the ultimate solution if the supplier is not playing ball, but it is a solution that has its own potentially harmful side effects.

If the arrangement terminates the customer will have to move to another service provider or take the services back in-house. Depending upon the nature of the services this can be a complicated, disruptive and lengthy matter. A sensible yardstick for the possible side effects will be the time and level of disruption involved in setting up the outsource in the first place. Detailed consideration should also be given before threatening termination as to what provision has been made in the contract for termination assistance. If there are inadequate termination assistance provisions, the certainty of disruption comes closer.

As an alternative customers should consider what incentives they may be able to offer the supplier with a view to persuading the supplier to renegotiate without the threat of termination. It may be the case that an extended contract period on the new terms proposed by the customer will be attractive to the supplier. It may also be the case that additional services and/or an upwards adjustment to the pricing will also be effective.

Conclusion

Of course, renegotiation should be avoided at all costs and this places emphasis on getting the contract right in the first place. Often a greater focus on building in flexibility and the mechanisms for regular review and consequential adjustment can help keep the contract in flavour longer. However, in the real world customers are regularly faced with the uncomfortable option of renegotiation or termination. In those circumstances preparation is key and must commence with a cold hard look at the business case, attention to the reasons that have led to the need to renegotiate and a realistic assessment of how the supplier can be persuaded to negotiate fairly. Customers must also change what appears to be the prevalent practice of giving renegotiation significantly less priority than the negotiation of fresh arrangements.

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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