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Out it in the Contract

Put It All in the Contract

How to avoid 10 potential issues in your outsourcing relationship.

BY JOHN A. GLIEDMAN

What does the contract say? That's a common question in the business world, and no less so than in an outsourcing relationship, which may last for years. Trouble is, this question is usually asked too late. The customer or service provider in an IT or business process outsourcing arrangement all too often realizes mid-way into the relationship that they had not followed the contract or that the contract fails to address the issue.

If your company is going the outsourcing route, or if your company is an outsourcing service provider, the services contract and its attachments are an essential user's manual to the business relationship that lies ahead. The contract is more than just legalese. Properly drafted and understood, the contract captures the financial and operational elements of the parties' relationship. Adhering to a clear and even-handed contract will discipline the parties' conduct throughout their relationship so that they act predictably towards one another and prevent surprises.

What follows are ten surprises that ideally could have been prevented by more careful planning and drafting of the relatively little understood but all-important outsourcing contract. There are five for the customer and five for the outsourcing provider.


5 Surprises � and Preventions � for the Customer
Surprise No. 1: "Every time that we want the service provider to perform new work, we receive an additional invoice for fees. Is this right?"
Preventative No. 1: The contract's description of services should be clear enough to avoid later questions over what services are in scope under the contract and what constitutes a change to be addressed by extra fees.

Surprise No. 2: "The service provider wants to use a subcontractor and take some of the services offshore. Is this allowed? We cannot find this mentioned one way or another in the contract."
Preventative No. 2: The contract should clarify whether and to what degree the customer will have input into how services are performed.

Surprise No. 3: "The service provider is exceeding service levels as set forth in the contract four years ago, but it is not taking advantage of changes in technology to improve performance. What can we do?"
Preventative No. 3: The contract should require the customer to change the services to keep pace with technological advances. In addition, there should be an obligation of improved performance over time based on increased experience and economies of scale, and a procedure for benchmarking the services against improved industry standards.

Surprise No. 4: "Don't we own the service provider's work product? After all, we are paying for it."
Preventative No. 4: The contract should clarify which party owns work performed on behalf of the customer rather than leave this matter open to question or later negotiation.

Surprise No. 5: "The service provider has not done anything wrong, but we want to pursue another solution and get out of this relationship. How does this work?"
Preventative No. 5: The contract should give the customer a right to terminate the contract for its convenience. The contract would normally specify fees due to the service provider upon such a termination.


5 Surprises � and Preventions � for the Provider
Surprise No. 6: "Our fees are fixed, but our internal costs keep rising. Isn't there any way to get the customer to pay for some of these costs?"
Preventative No. 6: Anticipate the problem of internal costs increasing excessively. One way to do this is for the contract to reference a budget based on a forecast of services to be provided. Weekly reviews can be used to manage the services to budget, monitor the service provider's efficiency and increase the budget if warranted. The contract should also allow for fee increases pegged to the cost of living.

Surprise No. 7: "The customer thinks that since it has outsourced its operations, it lacks any responsibility to give us assistance in running those operation. Isn't this a two-way relationship?"
Preventative No. 7: The contract should clearly set forth the division of responsibility between the service provider and the customer. Usually, the service provider will have primary responsibility for the performance of various itemized tasks and the customer will have the right of input and approval.

Surprise No. 8: "We are constantly exceeding expectations and service levels, but that does not seem to register with anyone. How can I more clearly prove to the customer, and my board of directors, how well we are doing?"
Preventative No. 8: The contract should contain provisions for sharing of cost savings between the service provider and the customer, as well as bonuses for the service provider's markedly exceeding service levels.

Surprise No. 9: "The customer has expanded its operation into a new state and wants us to pay for researching that state's laws and for registering to do business in that state. Which party has to pay for these costs?"
Preventative No. 9: The contract should clarify which party is responsible for paying for compliance with new laws and required licenses.

Surprise No. 10: "We have a billing dispute with the customer, but the contract only allows for dispute resolution by going to court. Isn't there a middle ground between giving up and initiating a full-blown lawsuit?"
Preventative No. 10: The contract should require both parties' senior management to sit down and handle any dispute that lingers for more than a month. The parties should first attempt to resolve the dispute without having to avail themselves of more formal dispute resolution procedures, and the ill will and costs that may result.


Conclusion
A clear outsourcing contract is critical to a successful outsourcing. Of course, good will and flexibility between the parties will prevent most issues from getting out of hand and go a long way toward making a relationship thrive. However, outsourcing relationships are long-term and complex, and one needs a predictable means of staying on top of potential problems. Therefore, the parties should prepare the contract carefully and consult it early and often.

John A. Gliedman is counsel with the law firm of Brown Raysman Millstein Felder & Steiner LLP, which has offices in New York, New Jersey, Connecticut and California. He specializes in IT and business process services agreements as well as intellectual property licensing. He may be reached at
jgliedman@brownraysman.com.

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