There are a number of practical steps that outsourcing customers can take when an outsourcing relationship develops serious problems that cannot be solved through normal governance processes. By using a step-by-step framework for managing disputes, customers can get their outsourcing relationships back on track. Alternatively, they may use these steps to pursue other alternatives (such as removal of affected scope) in an organized, minimally disruptive manner.
How Did We Get Here?
Problems develop in outsourcing relationships from a variety of unfortunate circumstances, such as: (1) mismatched expectations between the customer and the supplier; (2) changes that were not anticipated at the time of contract formation; (3) competing internal goals of the customer (for example, transformation versus cost savings); (4) poor performance by the supplier; (5) value not being delivered by the supplier; (6) below-market supplier compensation; and (7) mistakes of fact in contract formation. Many of these problems can be managed and resolved through a dispute resolution process that supplements governance. Some more serious problems may require assistance through more formal dispute resolution procedures.
Immediate Steps: Managing a Dispute While Day-to-Day Business Must Continue
When a dispute becomes serious, there are a few steps you must take to protect your company:
In addition to these unilateral actions that a customer should take, you should consider requesting that the parties enter into a "non-use" agreement or a "standstill" agreement. Non-use agreements prevent settlement discussions from being used in future litigation or arbitration. Standstill agreements are similar to non-use agreements, but they also "stop" time periods from running, and preserve the parties' rights while they work to resolve their disputes. These agreements can permit more open and constructive communication between customer and supplier during dispute resolution.
Framework for Managing Disputes
After you have completed these initial steps, you will need a proven method for managing and resolving the dispute. The following framework outlines a series of actions to take before you engage in further discussions with the supplier. These steps will ensure that you properly understand the scope of the dispute and will help you reach the best possible outcome for your company. All of these steps should be completed under the supervision, and at the direction, of your legal team to best preserve attorney-client privilege, and to best define your rights and obligations.
Frame the Issues
Step one is to identify all open issues and disputes in the relationship, and gather relevant facts and data. Investigate and verify the facts you have been given by interviewing employees, and by organizing a written record of the dispute's progression as documented in emails, notes from governance meetings, correspondence and other materials. The complex subject matter of many outsourcing deals can result in information gaps that you will need to fill before proceeding. Circumstances may have changed significantly since the contract formation, so make sure that you have current information.
After gathering all the relevant information, develop answers to the questions that really matter:
After going through this process, state the issues in writing, and make sure that your customer team agrees with your statement of the issues.
Assess the Issues
After you have defined the issues through the framing step, you need to assess each issue to ultimately develop your position. Review the agreement and evaluate your strengths, weaknesses and contractual remedies. Remedies may include termination, litigation, arbitration, partial termination, damages, indemnity, injunctive relief or some combination of these steps. Review the parties' positions in any similar (or related) disputes. Identify disputes that will be harder to resolve because they are more important to one or both sides.
Before escalating any issue, you should evaluate the "value" of the dispute in comparison to the value of the outsourcing agreement as a whole. Monetize each matter in the dispute and assess whether it is worth spending additional time and resources to resolve. Some issues may be conceded or "traded" for an issue that is more important to your company.
Determine where the customer may have leverage to encourage a favorable resolution. Many outsourcing agreements allow customers to in-source or re-source work to other providers, which can create effective leverage in discussions with a supplier who wants to keep the work. Determine whether the supplier's behavior is the type that is excluded from contractual caps on liability (willful misconduct being one example) and how that might influence the supplier to cooperate in a resolution. Consider exercising rights that you have by contract but that you have not exercised, as these may spur constructive changes. Examples include customer audit or benchmarking rights.
You also need to understand the supplier’s leverage points. For example, the supplier could reduce the quality or timeliness of service without committing a breach of the contract. Improper withholding of invoiced amounts could trigger supplier rights under an agreement to require escrow of disputed charges, or even to terminate for non-payment under certain circumstances. An understanding of the economic/strategy drivers behind the supplier's position is vital to a full grasp of the situation. In particular, it is important to assess whether the supplier is performing at a loss, because that will be a key driver of its negotiating positions.
The final step in the assessment process is to write a Customer Position Paper. This paper should state (1) the framed issues, (2) the customer arguments and leverage points, and (3) the supplier arguments and possible leverage points. The Customer Position Paper should also evaluate the strengths and weaknesses of the customer's positions, and prioritize the issues based on their value and the business goals they impact.
Define a Successful Outcome
With the Customer Position Paper in hand, the next step is to determine the outcome that you want to achieve in dispute resolution. This desired outcome must take into account the relative strengths, weaknesses and business priorities that have been defined in the assessment phase. Your contracting team (including your attorney) should develop a Term Sheet that proposes how to resolve the issues in accordance with your desired outcome. The Term Sheet process is somewhat like the process of contract negotiation. You must remember your desired ending point and structure a Term Sheet that allows room for compromise and movement on issues so that you end at or near your desired outcomes on the issues that most matter to your company.
As part of the Term Sheet, to better guide amendment or restructuring discussions, classify the agreement terms and schedules based on how much change (if any) they will need. Potential classifications could include:
In putting together the Term Sheet, it is important to remember that for many disputes, the party “at fault” is not always entirely clear. If a customer approaches every issue as if the supplier is completely wrong, or attempts to put every financial burden associated with an issue on the supplier, it may not solve the disputes and problems in the long run. A bad (uneconomical or impractical) deal for a supplier will ultimately become a bad deal for the customer. The supplier will not, or will be unable to, perform, and the customer will not achieve its business goals. When that occurs, both parties possibly face a lengthy and expensive dispute resolution.
Plan the Negotiation
Develop an overarching Negotiation Plan, distinct from the internal Customer Position Paper discussed previously, that will govern discussions with the supplier. First, establish the process to be followed for dispute resolution (similar to the negotiation process used to enter the deal originally), and detail the time frames for resolution. Create a meeting plan with dates, topics, participants and meeting objectives. Map the desired communication points between customer and supplier (which may vary depending on the issue). Without compromising negotiation strategy, if it is possible to state the desired end result with the supplier (such as amendment to the contract, termination of the contract or another solution), make that result clear to the supplier.
Having followed the preparation steps listed above, your team should now be well prepared to engage the supplier in dispute resolution discussions. You should share a copy of the Term Sheet and the Negotiation Plan with the supplier. Solicit feedback and comments from the supplier and modify the Term Sheet and Negotiation Plan as necessary. Come to agreement on the plan, especially regarding changes to the agreement and schedules, and determine (if possible) what would be a mutually successful outcome. Ultimately, when you come to agreement on the Term Sheet, the dispute is well on its way to resolution.
Overall, customers need to remember that business goals should drive dispute behavior, rather than dispute behavior driving the business outcome. In "escalated" executive dialogue and mediation, the parties define the issues and control how they are resolved. In arbitration or litigation, judges or arbitrators, along with litigation counsel, define the issues and control how they are resolved. There are disputes where litigation or arbitration may be the only practical means of resolution. In outsourcing deals, however, where the parties have to work together cooperatively for many years, solving disputes by negotiation rather than litigation or arbitration is by far the better path. Following the framework approach set forth above helps customers identify their business goals, sets the framework for proper behavior before and during negotiations, and defines an effective path for ultimate resolution of the dispute.
Joseph Pennell, an associate in the Business & Technology Sourcing practice, represents clients in information technology and business process outsourcing arrangements. He also assists in information technology licensing and development transactions. Additionally, Joseph counsels clients on privacy and security issues.
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