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Considerations in Exiting Outsourcing Deals

23 October 2014
Mayer Brown Newsletter

Exiting an outsourcing deal requires careful planning. A well thought-out exit plan can help transitioned-out activities proceed in a more orderly manner. However, there are often problems in the customer-supplier relationship that make a successful exit difficult. For example, the customer may be unprepared at exit because it has not governed the relationship effectively. Likewise, the outgoing supplier may be unmotivated to provide adequate disengagement assistance and could even act in a hostile manner. This article will discuss items that inside counsel should consider and how to mitigate the risks of exiting an out-sourcing relationship.

Exit Plan and Timing Considerations
Exiting customers should ensure that an exit plan is developed to allow adequate time to complete all activities, especially time to complete transition-out tasks. Inside counsel and impacted business stakeholders should work together to develop the exit plan to ensure that legal and operational issues are addressed. To the extent possible, the plan should be developed before termination or non-renewal notice is given to the supplier. If the services are not being moved in-house, the customer should also assess the timing required to reach agreement with a new supplier and provide adequate time for transition-in activities.

Utilize Contractual Rights
A well-crafted outsourcing agreement should contain options that can help the customer move from one supplier to another. For example, a common obligation will require the supplier to perform disengagement services for a period of time, regardless of the reason for termination. It is common for the supplier to perform disengagement services in accordance with the same standards used to perform steady-state services, including adherence to service levels.

If there are supplier personnel whom the customer believes are critical to the success of disengagement services, the supplier should retain those employees on the customer’s engagement for the required duration. However, the supplier will be motivated to pull its best employees off the engagement as quickly as possible. If your outsourcing agreement does not contain an obligation to retain such employees, consider cashing in some IOU’s in exchange for assurances that critical talent and knowledge will not leave shortly after notice of termination is given.

The agreement may also specify certain rights regarding software, equipment, and other materials used to perform the services. All customer-owned materials, including materials developed by the supplier, should be delivered to the customer upon request. Despite contractual obligations to maintain an inventory of all developed materials, customers may find that these lists have not been adequately maintained. The disengagement plan should include a work stream to verify that all such materials are accounted for and delivered to the customer in a timely manner.

Certain rights to supplier intellectual property may also be documented in the agreement. However, the rise of cloud computing and other IT “as a service” offerings are diminishing the customer’s need for (and the supplier’s willingness to provide access to) supplier intellectual property.

Information and Data Considerations
There are several data items that a customer needs to plan for when exiting an outsourcing relationship. Customer data should be returned to the customer upon request in a format reasonably requested by the customer. This is a bit more challenging in a cloud environment, though. For example, determining where data resides could be more difficult in a cloud environment and the supplier may be reluctant to provide the data in a different format without additional compensation. Some cloud providers may have policies that automatically delete data a short period of time after termination, so a customer with data in the cloud will need to quickly develop a plan for return of its data.

If a customer plans to solicit proposals from other suppliers, it needs to determine what information from the current agreement can be shared with other suppliers to enable them to formulate a proposal. While suppliers have traditionally resisted sharing financial information, some suppliers have also taken the stance that operational data, such as service level performance, is confidential information and thus cannot be shared. New proposals will more closely reflect customer requirements as more information regarding the current environment can be shared via the RFP process. Ideally, it’s optimal to define these information requirements during negotiation of the agreement to avoid a “blind spot” on the RFP.

Knowledge Transfer and Cooperation
Despite the right to have critical supplier personnel retained for the engagement during the performance of disengagement services, there are other supplier personnel who are not included in this group and are most likely anxious to move to new assignments. This presents a challenge for knowledge transfer, but early planning will help identify the transfer activities that need to occur so job shadowing can be built into the disengagement plan. Customers may also consider payment of retention bonuses to ensure that supplier personnel remain in their roles. However, a well-crafted agreement can avoid this financial carrot by specifying certain activities that the supplier needs to perform as part of disengagement services, such as training customer (or new supplier) personnel, cataloging all business processes and work procedures, and assisting in parallel operations until the services have been successful transitioned.

Ensuring cooperation between exiting and incoming suppliers is another challenge that can be mitigated by obligating the exiting supplier to cooperate with the new supplier as part of disengagement services. However, suppliers should be motivated to provide such cooperation instinctively out of fear of developing an “uncooperative” reputation.

Other Concerns
In the event that an agreement is terminated due to a material breach by the supplier, the customer needs to evaluate whether curing that material breach is necessary before exit. That may not be possible for some breaches, but perhaps there are fundamental operational issues that must be addressed before a new supplier begins to provide the services. 

If the relationship between the customer and the supplier is acrimonious, problems of trust may develop. A supplier may be unwilling to provide waivers or simply refuse to perform its obligations. In such instances, involvement by senior executives of both parties may be required.

In summary, the key to successfully exiting an outsourcing agreement starts with proper planning to assess all the activities and timing necessary to transition the services to a new provider. This requires inside counsel to work closely with business stakeholders with an eye to leveraging the contractual rights in the outsourcing agreement.

This article was originally published by Inside Counsel.

Authors

  • Daniel A. Masur
    T +1 202 263 3226
  • Derek J. Schaffner
    T +1 202 263 3732

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