Exit management planning for outsourcing agreements

August 2014 | EXPERT BRIEFING | RISK MANAGEMENT

financierworldwide.com

An Exit Management Plan (EMP) is essential to any outsourcing agreement, but it is often overlooked at the time when it should be given the most attention – during the formation of the contract. Consideration of an EMP at the start of a contract is sometimes likened to consideration of divorce when planning for a wedding. The connotations of this sort of commercial prenup seem negative, but let's reflect on this for a moment. The purpose of an EMP is to agree on a set of procedures which is fair to both sides, and the best time to do this is at a time when the relationship is healthy, so that argument may be avoided in the future when the relationship may have deteriorated; sounds good, right?

While the logic above holds true, we can put the marriage metaphor to one side at this point because EMPs are not a tool exclusively used for the resolution of contentious disputes. The vast majority of contracts are designed to come to an end at some point, and EMPs should be designed to deal with this inevitability.

Most outsourcing agreements involve IT at some level simply because modern business is so heavily reliant on computer systems. Often this will involve handing over or maintaining complex systems (which a business may be totally reliant upon and which the business owner may not fully understand), and in this context EMPs are critical to the protection of the customer’s business position. They should be prepared during the formation of a contract and updated regularly because, simply put, both parties will benefit from a fair and thorough EMP.

Legal considerations

In many IT outsourcing disputes between customers and suppliers, it is apparent that little or no proper thought has been given to dispute resolution, or indeed exit management generally. Why is it that the EMPs are often given so little attention? The answer appears to be that, at the time of signing the contract, the parties have been involved in negotiating the terms of engagement over a period of weeks or months, and at last they are entering into a new arrangement. Understandably, termination, especially in distressed circumstances where a customer terminates for default by the supplier, is not at the forefront of peoples’ minds. Contract award is the honeymoon period of a commercial relationship, in which there is no thought of divorce. Therefore, more often than not, the schedule in the contract which is meant to contain the EMP is left blank, or is only partially completed.

In a number of cases the EMP may have been completed, but is ambiguous as to the obligations on the outgoing supplier. This is particularly problematic where there has been a termination for supplier default. The replacement supplier will have dependencies on the outgoing supplier to supply information, and to cooperate with the transition arrangements. However, a termination for default does not tend to encourage cooperation by the outgoing supplier, which usually sees its revenue stream disappearing into the hands of a competitor. Failure to place clear obligations relating to these matters in the EMP have enabled outgoing suppliers to frustrate a timely and orderly transition to the point where the replacement supplier may be in breach of its obligations to the customer. Worse still is the situation where there is no EMP, and the outgoing supplier is able to forcibly negotiate generous rates to provide transitional assistance.

In outsourcing contracts, customers are increasingly looking towards multi-sourcing and the use of service tower models. These allow end-to-end IT services to be achieved by different suppliers delivering different services, and permit one or more of these providers to take over a tower service from a non-performing provider. Even with the advent of System Integration and Management (SIAM) – service providers who help customer organisations with multi-source outsourcing arrangements – there is still the need for a properly drafted EMP. The contract should provide that the EMP be periodically reviewed and updated (using Change Control provisions), as this will allow a number of disputes arising from a genuine misunderstanding of the supplier’s exit obligations to be minimised. Such a contractual approach to an EMP will also help SIAM providers resolve any issues between outgoing and replacement suppliers.

Technical considerations

EMPs need to be well rounded plans which give proper attention to all aspects of exit management, whether through dispute resolution or simply by contractual expiry. However, one of the issues that tends to arise is that termination for either party’s breach is likely to see a more guarded approach to EMP discussions.

Furthermore, when an outsourcing agreement reaches its end, it is often the case that the parties discover that they had agreed to meet and draft an EMP within 12 months, but it is not uncommon for them to have failed to follow through with this. Alternatively, it is sometimes the case that the parties have invested time in exit management planning, but have later engaged in transformational projects which render the initial EMP irrelevant.

With a simple view of the negotiation leverage, it is better for both parties to give proper attention to exit management prior to entry into an agreement. With this in mind, the parties should consider a number of issues which are discussed below.

Service expectations during the exit transition can have a tremendous impact on either party. The supplier will want to know what resources it must commit to an agreement which is about to end, and what it can commit to finding new customers. The customer, on the other hand, will want to ensure that they receive high levels of service right up to the point where the contract ends. A good EMP needs to consider both of these issues.

A pre-agreed cost of exit should, if possible, be built into the EMP. This is not always possible to achieve but, when it is, it brings the benefit of focusing the supplier on exit efficiency. However, be cautious when constructing such a term so that it cannot be construed as meaning the supplier must only put in a ‘fixed effort’. The alternative is for the customer to pay on a time and material basis, but this is open to dispute over quantum or quality of the services delivered.

There should be an obligation to conduct reviews (annually or quarterly, etc.) on an EMP. A common purpose of an outsourcing agreement is to alter infrastructure, and to improve efficiency and costs. An EMP needs to be updated to consider the impact of any of these changes. If this isn’t done you may, for example, face a situation where an EMP provides that, “server hardware will be transferred to the customer’s data centre”, but since the start of the agreement, all servers had been virtualised and are now hosted on the supplier’s server which is shared with its other customers. The concept of ‘all server hardware’, is no longer fit for the current situation, and is likely to cause dispute.

If it is the case that there will be a replacement supplier, the EMP will need to provide that the incumbent supplier works closely enough with the replacement to ensure a smooth transition, even though they may be competitors. Essential information and know-how will need to be passed on to the new supplier, and terms of engagement need to be negotiated to set out things like what record keeping is required for any meetings between suppliers.

Finally, parties should consider agreeing to consult an independent expert determinator to be instructed to oversee the exit process to ensure that each party is discharging their exit obligations. This is often difficult to achieve if the termination is contentious.
In summary, whilst relations are good at the beginning of the contract parties should make detailed provisions for its end, and make it part of the change control process that the EMP is regularly checked and, if necessary, updated to reflect changes to the contract.

Tony Sykes and Jason Coyne are partners at IT Group UK Limited, and Rob McCallough is a partner at Pinsent Masons. Mr Sykes can be contacted on +44 (0) 207 096 3791 or by email: dasykes@itgroup-uk.com. Mr Coyne can be contacted on +44 (0)845 226 0331 or by email: jasoncoyne@itgroup-uk.com. Mr McCallough can be contacted on + 44 (0) 20 7490 6236 or by email: robert.mccallough@pinsentmasons.com.#

Tony Sykes, Jason Coyne and Rob McCallough

IT Group UK Limited