The first article in this two-part series examined the key issues surrounding the transition into an outsourcing relationship (take-off). This article addresses the flip side of the agreement: key issues counsel should consider for successfully transitioning services back to the company, or to another supplier, after an outsourcing agreement terminates (landing).
A smooth landing
To prepare for terminating outsourced services, an outsourcing agreement should address the following issues:
1. Reasons to terminate
The agreement should address any and all potential reasons to terminate the relationship, including the completion of the purpose of the outsourcing relationship, breach of the agreement and convenience, which will likely come at a price to the terminating party.
Termination rights may be triggered by certain events such as non-payment by the company, a change in ownership of the parties to a competitor, recurring failures to achieve service levels, the supplier’s failure to adjust pricing after a benchmarking event, an extended force majeure event, or a party's change in financial condition (or bankruptcy).
Additionally, there may be events that have the “look” of a termination that should also be addressed in the agreement. These could include:
- Divestitures by the company
- Extraordinary business events, such as a downturn in the company’s business, a plant or product line closing, or the company’s complete exit from the type of business
- The company’s in-sourcing or re-sourcing all or part of the services, where allowed.
2. Whole or partial termination?
Partial termination of services may be appropriate in cases where the parties may not want to end the entire outsourcing relationship. Depending on the nature of the services being outsourced, it may be more suitable to terminate at the “tower” level (a particular type of outsourced service) or a service group or groups within a particular tower. To create towers, the parties should consider which service groups will work together when structuring the deal.
Since all service groups are not equal in terms of size and revenue, the parties should agree on termination charges for individual service groups, as well as for the entire agreement. If partial termination occurs, the agreement should adjust the service baselines and price levels to reflect the new scope of services.
3. Post-termination rights
The company should have certain rights upon termination to help transition away from the outsourcing relationship. These may include rights to:
- Obtain transfer assistance services
- Secure copies of data and licenses for in-scope software
- Purchase in-scope hardware at book or fair-market value
- Lease or sublease dedicated facilities
- Assume subcontracts
- Hire in-scope personnel from the supplier
- Have audit rights of the supplier that continue past termination
The existence and form of these rights should be considered in the context of the type of services being outsourced and the rights that the company will need to continue running its business smoothly after the relationship ends.
4. Understanding the supplier’s solution
It is critical for counsel to understand exactly how the supplier provides outsourcing services to the company, so it can move forward after the end of the relationship. As part of moving forward, the company should seek certain rights and obligations from the supplier after termination, including a right to use the technology and materials used by the supplier.
While this is not a controversial point for commercially available materials, there may be tension between parties regarding the supplier’s proprietary materials. The supplier may be reluctant to license them post-termination, but counsel should consider negotiating a license if the materials are required to continue running the business.
Considering this, counsel should structure the agreement to require the company’s consent prior to supplier’s use of proprietary materials that are not available after termination and generally require the supplier to use industry available and compatible software, systems and materials. The priority here is to avoid “recreating the wheel” —and paying for it again.
5. Reasonable termination charges
It is preferable to avoid lump-sum termination charges, even with the right to deduct wind-down expenses that the company incurs. Instead, the company should seek to limit the charges to the following:
- Actual wind-down costs associated with stranded software licenses, equipment and third-party contracts, only if the company is able to purchase or assume such licenses, equipment and contracts
- Severance or redeployment costs for supplier employees working on the company’s account as of notice of termination or non-renewal, limited to salary and benefits for a defined period, and limited to the supplier’s plan as of the contract signing
- Miscellaneous defined wind-down costs, such as transition or other charges spread over the term
- An appropriate profit margin
In any event, the supplier should be obligated to use commercially reasonable efforts to avoid or minimize its termination-related costs. Additionally, the termination charges may be reduced for certain types of termination, such as termination for a change in law or for a change in control of the company.
6. Termination assistance
Following termination, the company should have an unconditional option to receive an adequate period of termination assistance services. "Adequate" will largely be defined by the type and scope of the services provided during the term. Each outsourcing deal may be different. Termination assistance may include continuing to provide the then-current services until transition back to the customer, assistance with the preparation of a request for proposal (RFP) for a new service provider or requirements to work with the new service provider. Additionally, the termination assistance services may include services not originally in the scope of the agreement, such as data migration, project management migration, access to people and Q&A access. These extra services will likely involve additional fees, especially if they cannot be performed with the existing service provider personnel.
Paving the way
If counsel consider appropriate transition issues and prepare for the unwinding of the outsourcing arrangement early in the negotiation process, they can avoid disputes with the supplier, avoid unexpected costs and pave the way for a smooth transition and continued successful operations.