UK: Renegotiating Outsource Agreements

While nobody would question the fact that outsourcing is here to stay as a business model, many who have been burned by failed outsource arrangements are presently looking to escape from unhappy relationships with their suppliers or to renegotiate their outsourcing arrangements.

The customer's bargaining power is often significantly reduced in the renegotiation of an outsource agreement as opposed to the negotiation of a fresh contract. This article considers some ways of levelling the playing field.

Well-drafted outsource contracts should have the tools for audit reviews built into them. Benchmarking clauses, service improvement planning, annual review meetings, steering committees and other similar devices are all used to provide methods for customers to monitor the performance and price of the arrangements to which they have subscribed.

A pre-requisite for any review is the availability of accurate and pertinent data. If the contract contains provisions for the creation of management information and other such performance reports, the necessary facts should be readily available for review. Even if such requirements have not been specifically addressed, contracts often include general rights of audit providing a right to access the information required for such a review.

If the contract provides for an annual review, that would usually be the appropriate forum in which to raise the outcome of the audit of performance and pricing data. However, such provisions are not essential as the customer can always request a performance and pricing review without reference to a contractual term.

If the "soft" forum (above) proves unsuccessful, the customer may have recourse to a benchmarking clause. This usually provides a contractual mechanism for an independent benchmarker to carry out a review, with reference to a comparison group, and provide an opinion on whether performance meets a generally-accepted standard or whether the price is competitive. Benchmarking can be a very useful tool to police the technology and savings clauses as the benchmarker can test a supplier’s performance in driving down cost or implementing new technology against that supplier’s peer group. Key to effective benchmarking clauses are the provisions that apply if the benchmark identifies a discrepancy in performance or price. The absence of a clear mechanism to address the results of benchmarking can lead the parties into dispute as seen in Cable & Wireless plc v IBM UK Ltd (2002). While there are no prescribed ways to deal with the response to a poor benchmark report, it is suggested that an equitable route is to establish a period of time within which the performance deficiency must be remedied and/or the pricing is brought into line with the peer group average. If the supplier fails to comply within the allotted time, the customer should be entitled to terminate the agreement. The advantages of the soft forum and benchmark options outlined above are that, being designed to operate within the term of the agreement, they should not threaten the relationship and give rise to a termination.

A further option is the threat of termination. However, that can create bad feeling and sour negotiations.

Some contracts have break clauses entitling parties to bring an arrangement to an early conclusion. The threat to operate the right to break is often used to gain leverage in negotiations on the grounds that, unless certain changes are made to the way in which the contract is performed or the services are priced, the contract will be terminated.

In the absence of a break clause, the supplier’s conduct is often scrutinised to establish if there has been a breach or series of breaches that will permit termination. Usually, the right to terminate depends upon the breach being material (indeed the decision in Peregrine Systems Ltd v Steria Ltd (2005) requires the breach to be repudiatory) and the supplier failing to remedy the breach within a contractually agreed remedy period.

A customer’s bargaining power is greatest when a supplier is competing with other potential suppliers for the award of a contract. Once the contract is underway, the customer’s bargaining power is significantly reduced. While customers often threaten termination in order to recover negotiating leverage, caution is advised. Termination may be the ultimate solution, but it has potentially harmful side-effects.

If the arrangement terminates, the customer will have to appoint another service provider or take the services back in-house.

Depending upon the nature of the services, this can be a complicated, disruptive and lengthy matter. A sensible yardstick for the possible side-effects will be the time and level of disruption involved in setting up the outsource in the first place. Before threatening termination, detailed consideration should be given to any contractual provisions for termination assistance. If these are inadequate, the certainty of disruption increases.

As an alternative, customers should consider what incentives can be offered to persuade the supplier to renegotiate without threatening termination. An extended contract period, on new terms proposed by the customer, may be attractive to the supplier. Additional services and/or an upwards adjustment to the pricing may also prove attractive.

There is no substitute for getting the contract right at the outset, and renegotiation should be avoided at all costs. However, in the real world customers are regularly faced with the uncomfortable option of renegotiation or termination. In those circumstances, preparation is key and must commence with a cold hard look at the business case, attention to the reasons for renegotiation and a realistic assessment of how the supplier can be persuaded to negotiate fairly. Customers should also avoid giving renegotiation significantly less priority than the negotiation of fresh arrangements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.