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Keeping Sourcing Contracts Out of Court
Outsourcing agreements aren’t new; they’ve been in vogue in America since Washington invited Prussian soldiers to train his army at Valley Forge. And it’s a safe bet that litigation over outsourcing agreements—all manner of sourcing contracts, really—wasn’t far behind.
How do you as in-house counsel help your company avoid litigation over an outsourcing agreement? The best way is to be smart in drafting the agreement, says Ross Docksey, a partner with SNR Denton in Chicago. Docksey has seen a significant number of remarkably poorly written contracts in 20 years of practice and says they all too often lead to significant corporate disappointment with the contract—and sometimes to lawsuits.
One key to avoiding this corporate disappointment, Docksey suggests, is to be absolutely clear up front about your company’s needs and the reasons it is choosing to outsource in the first place. He draws a distinction between contracts outsourcing commoditized and non-commoditized functions. This distinction is important because it determines a number of things, including how hard or easy it would be to terminate the relationship with the provider should problems arise with service levels down the road. Terminating a provider of commoditized services would be relatively easy because agreements for purchasing substantially similar, easily produced and procured items are primarily based on price, and costs to switch to another provider are low; if the services are non-commoditized, a lot of highly sensitive information may be entrusted to the provider and it might be difficult to get that information back, and costs to switch to another provider are much higher.
“For me the key when you’re doing outsourcing is first to understand what sort of relationship you want,” Docksey says. “Are you looking for a business partner or are you looking for a provider of a commoditized service? And so the first thing that has to happen is that the customer has to decide whether it’s looking to do a procurement of services or whether it’s trying to build a partnering relationship with an entity that will function as a business partner responsible for running a part of its function.
“If you’re looking for someone who is going to help you navigate change over time, then you need sort of a mutually beneficial relationship; you need an alliance relationship. If you don’t expect change, if it’s pure commodity, divorce is easy and you don’t need that kind of alliance relationship.”
Docksey talks about the “expectations gap” between the customer’s requirements and the provider’s solution; he says this gap arises because of the way the contract is put together in the first place, with insufficient attention paid to the reason the company decided to outsource in the first place.
“While going through the contracting process, oftentimes the parties spend way too much time on the terms and conditions of the contract and way too much time on price and not enough time focused on the customer’s business expectations and focused on the way the provider will meet those expectations and focused on whether there’s really a match,” Docksey says. “So you’ve got to have a way to deal not just with what the provider is required to do, but the expectations gap between what the contract requires and what the customer ultimately is really going to want to be happy about the relationship.”
One way to address this is to have a provision in the contract saying that if, for example, there is a shift in the law that requires a change to the manner in which services are delivered, the parties will go through a process to determine how the contract should change. It’s important to build incentives to be sure that if it is necessary to revisit the contract to address a change in the law (or technology, or other business realities), the contract is revised fairly to all concerned.
None of this guarantees, of course, that the agreement won’t break down at some point, but keeping these points in mind when drafting the agreement will go a long way toward ensuring it will serve all sides well.