UK: Watch Out For ´Definitional Disconnect´ In Outsourcing Contracts

Last Updated: 21 June 2007
Article by John Buyers

Originally published on ITBusinessEdge, 24th January 2007.

With John Buyers, a partner and head of Commercial, Outsourcing and Technology at international law firm Stephenson Harwood. Buyers has practiced for many years as a lawyer in the IT and outsourcing industries, including at Elonex plc where he was general counsel and at Capgemini where he was lead international outsourcing counsel.

Question: Is it generally a good idea to use a draft contract from an outsourcing provider?

Buyers: There is a simple answer to this question, and in essence it applies to all draft outsourcing agreements, irrespective of whether they are submitted by the outsourcing customer or outsourcing provider. The answer is that the draft must "fit" the deal in all of its respects. The problem with many draft contracts supplied by outsourcing providers is that they adopt an off-the shelf "one size fits all" approach. Don’t forget that outsourcers will sign many such agreements over the course of a year, as opposed to customers entering into such a deal only once or twice. Suppliers will therefore have a well evolved "way" of doing things and invariably a mature contracting policy on such deals. The contract that they propose will reflect this "cookie cutter" method.
It is inevitable that such a standard form agreement will reflect the supplier’s position on every single aspect of the deal. It will therefore be restrictive in areas where the supplier perceives that they could lose money, such as, for example, liquidated damages and service credits. Conversely, such contract terms will make it very easy to enable the supplier to charge you for extras which you might think should be included in the base price. It may be that you are entering into a very simple generic outsourcing deal — in which case, such a contract may be the most economic way forward. It is questionable however (even at the bottom end of the scale) that such generic deals exist. In my practical experience, most deals are individually tailored and therefore the "cookie cutter" will not be appropriate. The clear principle is that if you take control over the drafting of the agreement, you can be sure that your interests will be reflected in it.

Question: What are some of the common errors or omissions in outsourcing contracts?

Buyers: Many errors and omissions can stem from the fact that the contract does not reflect the deal in all of its respects. As discussed earlier, this can sometimes happen when a supplier’s contract is used "off the shelf". In reality, it is rare to come across errors or omissions in the base terms and conditions governing the outsourcing per se, as these are based on mature and highly evolved contracts.

What does happen on a regular basis (and which can seriously affect the interpretation of the agreement) is a disconnect between the content of the contract terms and conditions and the contract schedules. This is because they are very often drafted by different teams of people. It is common to delegate schedule drafting to the supplier or to people who will be involved in the downstream service delivery of the outsourcing. Likewise, it is common to delegate the drafting of the terms and conditions to the lawyers. What many clients do not realize is that it is essential for these two groups of people to talk to each other!

The biggest issue is usually what I call "definitional disconnect". As most common concepts in an outsourcing agreement are complex, they usually require a definition. It is not unusual to come across situations where a concept is defined in the terms and conditions, and a completely separate one is used in the schedules, or even more confusingly, there is an overlap between two definitions used in the terms and conditions and in the schedules which are similar but not completely identical. Even a simple failure to use the defined terms for the parties in the schedules can cause interpretational issues (e.g., where the supplier company is referred to as "the Supplier" in the terms and conditions and XYZ co in the schedules). The simple solution to this is to ensure that your lawyers talk to the service delivery people and that you do not treat the creation of schedules as a separate process.

Question: What are the essentials to include in an outsourcing contract?

Buyers: My mantra is: Reflect the deal in the agreement. Again, this is less about focusing on the base terms and conditions but rather looking at the contract documents in their entirety, schedules and all.

The Parties: Have you clearly established who will be performing and who will be receiving the services? It's an extreme example, but if you’re a customer you might not necessarily be pleased to learn that the deal you signed with a billion-dollar outsourcing company will be performed by a two-man part-owned subsidiary domiciled in Haiti. Likewise, if you’re a supplier, you are not going to want to provide services to an entire group (including spun-out subsidiaries) if you have priced up service provision to one customer company.

The Services: Have the outsourced services been adequately reflected in the contract documentation? By services I mean a description of the actual process, the transitional and steady state service levels associated with it, and any "penalties" or service credits payable for failure to meet the specified service levels. If it is a business process outsourcing deal that you are entering into, consider whether flow diagrams showing visual representations of the outsourced services are appropriate. As per the old maxim, a picture tells a thousand words!

The Price : Deals founder on an inability to correctly set price. Make sure that as a customer you fully understand what is inclusive and what is not, and as part of this, always understand the pricing mechanisms in the agreement around change control. If you don’t, you could end up paying dearly. Likewise, as a supplier, ensure that you have the ability to review the pricing on the anniversary of each contract year. If you don’t, you could end up bearing the increases in labor and inflation rates.

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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