8 May 2015

Outsourcing contracts - do try this at home

We recently spent some time reviewing the UK Government’s latest template outsourcing agreement. It won’t appeal to everyone, but it’s a great benchmark for larger scale projects, and it’s freely available for download and non-commercial use.

However, pushing 400 pages (including schedules), it’s a big old read, so, in no particular order, we picked out nine of the more useful take-aways.

1. Third party warranties - With solutions increasingly integrating third party cloud-based services, customers are looking closer than ever at those third parties’ performance guarantees. However, as the customer doesn’t usually contract with those third parties, it’s technically the supplier who benefits from the guarantees, not the customer. The supplier can sometimes transfer these guarantees though, or if not, can hold them on trust for the customer. For added security, the supplier can delegate its rights in relation to the guarantees to the customer, under a power of attorney. (Clauses 5.5 and 5.13)

2. Off-the-shelf components - Whether the supplier’s or third parties’, commercial off-the-shelf (COTS) service components will usually be made available to the customer on their standard terms, which won’t always be equivalent to terms relating to the more project-specific components. Of course, those standard COTS terms need to permit the customer’s intended use, which may well also require third parties’ use too, so additional sub-licensing rights can be important, as can transfer rights, if the customer entity could change. (Clause 17)

3. Competitive terms - Larger customers (particularly governments) sometimes have more favourable terms from third parties than the supplier. Rather than using the supplier’s terms, relevant service components can be obtained under the customer’s terms, and the service charges reduced appropriately. (Clauses 15.14 to 15.16)

4. Service deductions - Setting service deductions can be difficult. They should deter failure, and otherwise enable the customer to quickly and easily obtain some compensation, but set them too high, and they risk being punitive and unenforceable. The key here is proportionality. Above a certain threshold (in this case, 50% KPI failure), the customer can fully withhold relevant service charges, but lesser failures need lower deductions. Of course, in some circumstances, the customer will want to seek additional compensation, through legal proceedings, if necessary. (Clauses 7.2 to 7.5) 

5. Performance measurement - During the contract term, the customer’s business requirements and priorities are probably going to shift to some extent. Beyond service scope flexibility (add/remove services, and up/down scale), flexible performance measurement can also ensure the core services continue to meet the customer’s evolving requirements. (Clauses 7.7 and 7.8)

6. Multi-sourcing - Multi-sourcing might be about as trendy as outsourcing gets, particularly as cloud solutions proliferate, but it’s not without its difficulties. When one solution fails, it’s quite possible it will impact others and in these cases, simplistic dispute resolution mechanisms can sometimes lead to rather perverse outcomes. Multi-party resolution needs to be available. (Schedule 8.3, paragraph 9)

7. Indirect and consequential losses - It may have become standard commercial practice to include catch-all exclusions of “indirect and consequential” losses, but when push comes to shove, the courts regularly deliver some rather surprising interpretations. Specifying recoverable losses (anticipated savings usually being quite important when outsourcing), leaves little room for confusion. (Clause 25.8 and, for further discussion, this  great Society for Computers and Law article co-authored by the excellent Michael Bywell.)

8. Proactive remedies - Step-in rights may be the fifth wheel of outsourcing contracts and their inclusion with cloud-based solutions is a practical nonsense. Requiring the supplier to work with a remedial adviser could help get the services back on track. (Clause 29)

9. Reduced value - If Aristotle once said, “the whole is greater than the sum of its parts,” that’s likely the case with many outsourced services. Should the customer not receive the whole of the services components, it may be appropriate either to return components delivered, or partially to refund payments already made. (Clauses 34.6 to 34.11)

6 comments:

  1. Thank you for the bite-size summary, David! very useful. Caroline Lueder

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    1. HI Caroline. Great to hear you've found it useful. Thanks for feeding back. David

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  2. G W Carmichael11 May 2015 at 14:54

    David. The problem with this contract is that it is too long and too complex to be used by business. Why is it that the IT legal community cannot be as concise as the construction industry? There are 2 issues i would draw attention to that you do not mention:
    1. Change in Law. This new version has perpetuated a defect in the previous OGC draft because the definition of Specific Change in Law is so narrow that there will never be one (because it will always affect a Comparable Supply).

    2. The Delay Payments provisions are highly problematic given that the supplier has to pay non-refundable payments even if the delay does not in fact occur. This drives the wrong behaviour.

    I would welcome comments on these points.

    George W Carmichael

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    1. Hi George. Great comments - thanks very much.

      I should just clarify that I focused only on some of the more useful, generically-applicable take-aways. As you say, the contract is massive, and an exhaustive critique would have been very lengthy indeed.

      Like you, I wish the IT legal community could be as concise as the construction industry. Many of your peers that I meet often point to the JCT as a construct (no pun intended) for improvement. Of course, the JCT model takes consensus, which might be one reason why IT lawyers are struggling. Also, a comfort in drafting by precedent, which seems to lead to longer and longer provisions. We’re clearly in need of shorter, simpler contracts, but somebody needs to take the time to sit down and write them - no mean feat in today’s business environment.

      On Specific Change in Law (SCL), it is certainly narrowly defined, and I tend to agree. Ignoring for now the (important) unique circumstance that the customer is also the legislator, if SCL were limited to the customer’s business (and so the Change in Law could affect Comparable Services), that would not be correct of itself, as it affects the supplier’s business more generally. Several private sector contracts I’ve seen recently compromise here, with the customers sharing the burden. That’s probably a fairer outcome, but of course with this contract we’re arguably dealing with a necessarily more risk-averse customer.

      On Delay Payments, my take is that Schedule 7 Part C aims to incentivise suppliers to call the delay early, giving the Authority advance notice, the quid pro quo being that having called early (and therefore limiting exposure for the potential delay), suppliers can’t then have their money back. It’s definitely a gamble. Presumably, you’re referring to the risk of suppliers calling early and so then allowing failure as they’ve lost their money anyway? I agree this doesn’t help anyone and there needs to be a mechanism (ideally a carrot not a stick) to keep things on track.

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  3. Anticipated savings as a deemed direct loss is always a keen topic of conversation in negotiations.. . . .In reality, proving the savings have not been achieved solely as a result of the Supplier's failure will be burdensome, I suspect

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    1. Absolutely, and many thanks for commenting on this.

      Clause 25.8 looks to be quite carefully drafted to entirely sidestep Hadley v Baxendale - i.e. anticipated savings are recoverable - no need to think about direct/indirect.

      That just leaves causation, and it’s worth noting the inclusion of the ‘to the extent’ wording, so failing to realise the losses probably doesn’t have to be solely caused by the supplier. I agree though, could be really hard to determine causation in practice.

      Perhaps the most valuable take away in this clause though, is the cross-reference to Schedule 7.6. It’s vitally important to specify the anticipated savings at the outset.

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