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Outsourcing Bust-Ups

Using the contract as a roadmap to navigate difficult terrain.

by John Gliedman, Thomas C. Greble

Many HRO transactions are announced with great hoopla, mutual compliments, and photographs of smiling executives. But those of us who live in the real world know that problems arise once the cameras are off. Just as there are successful outsourcing relationships that go the distance, there are many that reach bumpy terrain or lose direction all together. Although rarely publicized, such outsourcing bustups do happen, and prudence dictates that this possibility should be taken into account when drafting the outsourcing agreement. If a bust-up is inevitable, you want the terms of your contract to serve as your insurance policy.

A recent decision of the Texas Court of Appeals in Southern Union Company v. CSG Systems, 2005 WL 171349 (January 27, 2005) shows what can happen when an outsourcing partnership quickly loses momentum. Southern Union outsourced its print and mail operations to CSG Systems. After months of negotiations, the contract was signed on October 2000 with a go live date of December 2000. However, implementation problems arose, and Southern Union ceased work on the project in January 2001. It sued CSG Systems for breach of contract in February 2001. CSG Systems counterclaimed.

The outsourcing agreement in that case had a discontinuance fee clause that calculated CSGs damages in the event of discontinuance. The jury awarded CSG lost profits and a discontinuance fee in the amount of $2,351,000, plus interest and attorneys fees. In the end, the litigation took much longer and cost more than the implementation itself.

The first rule of avoiding a bust-up is to ensure regular, open communicationnot just troubleshooting as problems arise. Scheduled meetings force the parties to think about their relationship in a more strategic manner, help them understand each others business objectives and needs, and allow them to address issues in a calm setting away from the heat of a particular dispute. Additionally, the contract could contain a path of escalation through the chain of management on both sides to ensure that top decision makers are really making the key decisions.

But what provisions should you consider if negotiations to resuscitate the stricken relationship reach an impasse? Obviously, if one party materially breaches the agreement, the other party needs the right to terminate the agreement and recover appropriate damagesthat is the easy case. The agreement should also address situations where the relationship ends without a clear material breach. With a termination for convenience, a party gets out of the contract without having to prove that a material breach has occurred. It is reasonable to require a notice period before the effective date of termination and provisions for payment to the non-terminating party where parties agree on a buy-out of future obligations to pay under the contract. This sets the parties obligations rather than allowing these obligations to be determined by a jury.

The contract should also contain terms such as mediation clauses to formally resolve disputes that are not resolved in the normal course of affairs. Mediation is confidential, so trade secrets do not become public; it is faster and cheaper than litigation; and it ensures that a person accepted by both parties as fair and knowledgeable (a specific mediator can be designated in the agreement) is involved, rather than a jury unfamiliar with complicated business transactions.

Another alternative to full-scale litigation is arbitration a confidential process with a binding result. However, arbitration is not governed by a well-established set of case law and rules like litigation, so wait time for a final award can be lengthy. Moreover, the award is typically difficult to appeal successfully. If arbitration is provided for in the contract, be sure, at the least, to state that any arbitration is to be governed by the terms of the contract and insert other provisions necessary to restrict the arbitrators decision.

Good will, effective communications, and flexibility will prevent most issues from getting out of hand and go a long way toward making a relationship thrive. But if an outsourcing is headed for a bust-up, remember it is easier to deal with problems if both parties placed the proper terms in their contract. Planning ahead for such a contingency during negotiations is much easier than improvising after the fact. As the saying goes, hope for the best, but plan for the worst.

This article is for information purposes only. It is not legal advice.

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