A Solid Foundation

When IBM signed a $5 billion, seven-year deal to provide outsourced data-processing services for JPMorgan Chase & Co. in 2002, the company called the move "groundbreaking" and said it would "dramatically change the way IT is delivered." However, after JPMorgan Chase merged with Bank One in 2004, it opted to bring those services back in-house, leaving 4,000 IBM employees in the lurch and in effect disintegrating the contract.

"During the term of an outsourcing contract, things happen," said Debra Branom, manager of U.S. and Latin America business support at Electronic Data Systems Corp., a global technology services company. "Priorities shift and businesses ebb and flow."

According to the Everest Research Institute, an independent research and analysis organization, the global offshore market will reach upwards of $160 billion by 2009 and will continue to grow at an approximate rate of 33 percent a year for the next three years.

As the pace at which companies outsource IT and business functions increases, in-house counsel will play an important role in crafting the contracts that govern those arrangements. Branom and other attendees at a recent Martindale-Hubbell forum in New York titled "Best Practices in Tackling Corporate Outsourcing Contracts and Agreements" emphasized that building a strong foundation is critical to avoid costly legal problems down the road.

Back To Basics

According to a survey conducted by the Outsourcing Center, an outsourcing research company, the leading cause of the failure of an outsourcing agreement is "the buyer's unclear expectations up front as to its objectives."

However, bringing clarity to outsourcing contracts isn't an easy task.

"One of the problems with outsourcing contracts is they were written by lawyers for lawyers," said Robert Zahler, a partner at Pillsbury Winthrop Shaw Pittman and an attendee at the forum.

To make outsourcing contracts more business-friendly, Zahler and his team came up with an innovative solution. They create a visual representation of the agreement, which gives businesspeople, attorneys and consultants a tool to negotiate the deal, monitor service levels and create a clear picture of both party's expectations. The customized matrix outlines the physical elements required for the agreement (such as computers or servers) and the processes that will be performed as part of the agreement (such as acquisition, maintenance or storage), and then uses a color-coded scheme to denote each party's responsibilities.

"It defines in a very crisp way who's doing what, but also gives a good visual representation of exactly what the solution is," said Vipul Nishwala, partner who worked on developing the visual representation at Pillsbury.

The matrix serves as the actual contract, thus eliminating the need to comb through hundreds of pages of documents at the first sign of a problem.

However, no matter how fine-tuned the initial contract is, it can't account for the unpredictable nature of business relationships. Most outsourcing contracts span several years. Therefore, trying to determine the scope of the agreement up front without any knowledge of how both companies will evolve is often a root cause of future disputes.

Getting Collaborative

Although IBM and JPMorgan's outsourcing fallout was amicable, most contract conflict is impregnated with mistrust. And due to the unpredictable climate of outsourcing business functions either overseas or to a company down the street, participants agreed that setting up dispute-resolution methods preemptively is essential. Branom recommends incorporating a written agreement about how the parties will address disputes into the contract.

She suggests a "collaborative law" approach in which the parties agree to periodic status meetings involving two lawyers and two businesspeople from each party. That group will be responsible for discussing the shared goals and developing solutions to problems that arise over the course of the agreement.

Whether the problem is an unforeseen merger, an environmental disaster or even a minor disagreement as to how a party will perform an aspect of the contract, creating a climate of open dialog early on alleviates future strain.

"The collaborative law approach allows businesspeople to run the process, not the lawyers," Branom said. This more often leads to resolution of issues at lower cost to both parties.

And while the collaborative approach doesn't ensure that a dispute won't lead to a court date, it does provide the parties with frequent opportunities to discuss and resolve smaller issues before they snowball into costly litigation.

However, there may be a downside to getting lawyers involved in managing the relationship. Some attendees feared that this approach could create an adversarial relationship.

"The minute a lawyer is part of the team, you up the ante and it creates a more tense dynamic," said Wendy Schick-Dougall, assistant GC of American International Group Inc., an insurance and financial services company.

Not only could two lawyers sitting in on meetings create tension, but also the attorney's constant presence could lead to full blown litigation at the first hint of a dispute, some attendees said.

"What happens when there really is a dispute that occurs?" asked Bruce Ortwine, joint general manager and general counsel for The Sumitomo Trust & Banking Co. "Are they going to say this isn't working, so let's go straight into an adversarial relationship?"

Chicken and Egg

To combat the perception of an adversarial relationship, Sterling Spainhour, deputy general counsel of Wachovia Corp., developed a two-step governance framework to manage his client's outsourcing agreements.

The first level, called the operating committee, is made up of businesspeople from both sides who handle the actual day-to-day affairs. It is these people, Spainhour said, who are most capable of handling the myriad issues that come up during the outsourcing process.

If issues aren't resolved at the operating level, an executive committee is called in to quell the dispute. This committee contains five people from the supplier side and five people from Wachovia with Spainhour as a non-voting member.

"I am there simply to make sure that people understand the dynamic we are in now," Spainhour said. "Because the next step is arbitration."

While it is impossible to predict whether conflict will arise out of an outsourcing agreement, in-house counsel need to keep in mind that both parties have an interest in making it work.

"Neither side wants the agreement to fail," said Neil Olderman, partner at Gardner Carton & Douglas. "Both sides want to preserve the agreement and negotiate a solution."

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