Outsourcing – Key Considerations in Managing Negotiations With Subcontractors

In almost all business process outsourcing transactions it is virtually impossible for one service provider to perform all of the services required. So subcontractors become fundamental to the delivery of the services. Here’s our list of some key issues to manage when dealing with subcontractors. 

1. One Throat to Choke.
Or perhaps more politely, one hand to shake. Remember that whether your deal involves one subcontractor or a consortium of them, the customer will insist on the prime contractor remaining liable for performing all of the obligations under the outsourcing contract, regardless of whether some of the obligations have been subcontracted. As a result, it is essential that the prime contractor carefully and clearly identifies, and flows to its subcontractors, any and all obligations to be performed by the subcontractors to ensure complete performance of the services. Each link in the service delivery chain must be carefully considered from a business, technical, operational, financial and legal perspective to ensure that the liability for performance of the subcontracted obligations is appropriately and fully allocated, contractually, among the subcontractors. This is where negotiating limitations of liability (an certain other “sacred cow” provisions) can become tricky, as they are often the last agreement made before signing, and must be flowed through to the subcontractors.

2. Subcontractor Failures.
A failure under one subcontract may, in the context of that subcontract, be contained and relatively inconsequential, in the scheme of the larger deal. However, for the prime contractor, that failure may trigger onerous consequences under its contract with the customer. For example, a specific failure by a subcontractor may required that the subcontractor be removed from the deal. The removal of a subcontractor is never without consequences. In order to back stop the prime contractor’s obligations to its customer, the consequences of failure by the subcontractor, regardless of the materiality of the subcontract or the subcontractor’s obligations, must be addressed . . . carefully! 

3. Timing is Everything.
The time constraints involved in negotiating an outsourcing transaction are often unrealistic . . . and time is money for the prime contractor and the customer! While the negotiations between the customer and the prime contractor inevitably, completely absorb much of the negotiating time in an outsourcing deal, it is critical that the prime contractor engage its subcontractors early and often. It is even more critical that the customer keep tabs on the status of the subcontractor negotiations. The consequences of failing to manage the timing of the subcontractor negotiations range from delay to deal jeopardy.

4. Negotiating Strategy.
Ideally, the prime contractor and its subcontractors, as a team, will have a strategy in place as to various puts and takes that the prime contractor may have in its back pocket for negotiations with the customer. But we all know that deal teams do not live in ideal worlds. When negotiating complex outsourcing arrangements, the implications of decisions made at the core negotiation table (and sometimes the lack of decisions), can significantly impact the subcontractors. Additional due diligence may be required, the subcontractor’s solution or services may need to be re-tooled or completely over-hauled, or the subcontractor’s input (or multiple subcontractors’ input) is required to find a solution to a problem. All of this takes time and adds complexity. Good management of this process, behind the curtain from the customer, is essential to a smooth, successful deal, being completed on time. For the prime contractor, subcontractor negotiations can be a sizeable task (any magnified by the complexity of the transaction, the complexity of the solutions, the number of subcontractors to manage). 

Whether the prime contractor uses separate deal teams to negotiate the subcontracts running almost concurrently with the core table negotiations, or the subcontract negotiations take place on specific days of the week using the prime contractor team, or the prime contractor crystallizes the business deal first before negotiating with the subcontractors, or some other negotiation strategy is implemented, the prime contractor must have a plan and a strategy for managing its negotiations with subcontracts before it starts the negotiations with the customer. Mismanaged subcontractor negotiations not only jeopardize the entire outsourcing, but can also add significantly to the pre-contract deal costs of all involved.

5. Managing Subcontractor Defaults.
Key to the one throat to choke concept is the management of subcontractor defaults. Customers may often ask for one throat to choke (that is to say, only one party to the contract – the prime contractor), but when defaults occur, customers can sometimes be quick to jump the queue in an attempt to deal directly with the subcontractor. The relationships need to be honoured when addressing subcontractor defaults. This needs to be facilitated in the default provisions agreed to in the outsourcing contract. It is in the interests of both the customer and the prime contractor to ensure that notification periods, cure periods, reporting obligations, and problem escalation procedures will work from a practical level when flowed down to the subcontractor, and through the prime contractor as gate keeper. These processes and timelines should be carefully mapped out to ensure that workable processes can be managed that allow the parties to focus on solving the problem first, and dealing with the liabilities second.

6. Practical Realities.
While having one throat to choke, or one hand to shake, by directing all dealings with a subcontractor through a prime contractor may be the preferred approach for many customers, the customer and the subcontractor may need the ability to work directly with each other, instead of through the prime contractor. While the contract will customarily say that all dealings between the customer and the Subcontractor will be through the prime contractor, the on-the-ground operations will likely involve the co-operation of all three parties working together. Appropriate clauses should be negotiated between the customer and the prime contractor, and between the prime contractor and the Subcontractor, to facilitate the cooperation of the parties so they can they can work jointly together required (which may include joint decisions where they are all affected), while still honouring the concept of one hand to shake.