Managing Risks in Outsourcing during Exit

In previous blogs in September/October 2011 (Supplier Selection; Contract Negotiations; Relationship Management) I offered practical tips on how to manage and mitigate some of the risks that arise throughout the life cycle of a typical outsourcing. These risks may arise during the supplier selection process, in the course of contract negotiations or during the implementation and day to day operation of the outsourced services. In this final chapter on managing risks in outsourcing I will focus on exiting from an outsourcing contract.

The exit from an outsourcing deal gives rise to a variety of different risks for a customer, particularly an exit following termination due to the supplier’s default or termination for convenience by the customer.

Common risks which you may face as a customer upon exiting an outsourcing contract include:

• disruptions or discontinuity in the supply of the services to your organization,
• significant and unplanned costs,
• loss of critical assets, software, know-how or other intellectual property,
• delays in the exit process,
• damage to your reputation,
• unauthorized disclosures of your organization’s confidential or commercially sensitive information or data,
• being locked into specific but inflexible exit arrangements,
• loss of critical staff, and
• poor or insufficient termination assistance being provided by the exiting supplier.

To the extent feasible, you should address these risks at the outset of the outsourcing. Exit planning should not be left until a termination is imminent, as suppliers will have little motivation or desire to be cooperative and agree to customer-favorable terms at that point, particularly if the relationship has deteriorated.

Exit plan
Although the comprehensive exit plan often is produced after the outsourcing contract is signed (as it may not be practicable to prepare the exit plan in detail at the outset), the principles and content of the plan should be specified in the outsourcing contract.

The exit plan should cover:

• continued provision of the services for the duration of the termination notice period or the run-off to expiry and, if necessary, for a transitional period afterwards;
• the supplier’s obligation to provide information (knowledge transfer) relating to the services to your new supplier or you if the service is to be brought back in-house;
• terms addressing the transfer or licensing to you or your new supplier of assets, software, know-how and other intellectual property rights used by the existing supplier to deliver the services to you;
• transfer of records prepared or data collected by the existing supplier in connection with the services to you or your new supplier;
• transfer of relevant third party contracts to you or your new supplier;
• treatment of the existing supplier’s employees who are in scope;
• a process by which the supplier will provide reasonable assistance to you in connection with a re-tender of all or part of the services upon exit, and
• general assistance and co-operation between you and your existing supplier.

The exit plan should be reviewed regularly and updated to reflect any changes to the services that occur during the term of the outsourcing contract.

Existing supplier appoints a suitably qualified exit manager
Just as you would in respect of transition at the start of the outsourcing relationship, you should require the supplier to appoint a suitable exit manager to oversee the supplier’s compliance with exit terms and act as your liaison during the termination and exit period. Given the criticality of this role, you may wish to have the right to approve the exit manager.

Some particular issues that you should address at the time of negotiating the outsourcing contract so as to facilitate a smooth exit include:

Express right to continue to receive base services
The outsourcing contract should include an express right for you to continue to receive the base services for a reasonable period after the expiration or termination of the outsourcing contract. This will enable you to continue to receive the services if the transition of the services to a new supplier or in-house does not go to plan. Ideally, the supplier should be required to provide those services at the same level of quality (i.e. service levels) required under the outsourcing contract. You also should remain free to terminate the base services at any time upon notice.

Maintain comprehensive and up to date asset registers
While an exit plan would usually require the supplier to transfer to you an agreed list of equipment that it owns and uses for the services, that transfer becomes problematic if that equipment cannot be identified. This issue is potentially more complex where equipment to be transferred is commingled with shared infrastructure to be retained by the supplier. To reduce these risks the supplier should be required to maintain comprehensive and up to date asset registers during the course of the outsourcing contract. You should also give careful consideration as to what will happen with shared infrastructure when the outsourcing contract is terminated, particularly in relation to third party contracts which support this infrastructure.

Transfer of third party contracts
It is not usual for suppliers to have entered into third party contracts in connection with the provision of services. Some of these will be required by the customer or its replacement supplier following exit. The transfer of third party contracts is often contentious, but with some planning many of the problems that might arise can be avoided.

For example, you should:

• as with assets and equipment, ensure that all third party contacts can be easily identified and that a contracts database is established and maintained during the course of the outsourcing contract;
• require the existing supplier, when first entering into the third party contract, to make sure that the terms of those contracts include provisions that permit transfer upon exit and that there are no unreasonable provisions relating to such transfers to you or a new supplier;
• work with the existing supplier to coordinate the communication process with third parties as there will be issues about confidentiality which should be addressed proactively; and
• allow sufficient time in the exit process to obtain relevant third party consents and to implement the transfer of the relevant third party contracts.

Agree upfront who owns the developed intellectual property rights
During exit the ownership and use of intellectual property developed by the supplier during the course of the service provision can be a contentious issue. Who should own intellectual property in developments, the scope of any licences (such as whether they are perpetual or limited to internal business purposes of the customer, whether any licensing fees apply after exit) are matters for negotiation and should be agreed up front and not left until exit.

As with assets, equipment and contracts, it is important to identify what rights are to be the subject of the ownership or license discussions. Suppliers often fail to record adequately what they have developed. This issue can be avoided through effective contract management during the course of the outsourcing contract, in particular, by defining and recording what has been created by your supplier during the course of service provision.

Costs of exit
One of the most contentious area of exit is costs. The different types of costs or fees, when they will be payable and whether they are factored into the agreed pricing model, should be identified to avoid disputes and surprises at termination.

An outsourcing can be a complex transaction to negotiate and the different scenarios for exit can be difficult to document. However, anticipating these complexities and their associated risks at the outset and addressing them in the contract and through appropriate contract management can mitigate the risk of a contentious and unmanageable exit from the outsourcing contract.