An Old Adage

There is an old adage that goes: “a good arrangement between parties is one where the contract can be put away at the end of the negotiation and never looked at again.” And who can complain with the apparent wisdom of this adage? It implies that the parties are so sufficiently well aligned and cooperative that a written contract is merely a formality, and that any circumstances can be accommodated through rational and cooperative behavior. I’ve never met a businessperson who did not subscribe to this adage. And I myself never questioned its apparent wisdom until the past 24 months or so. I now believe that, while there may be transactions where this adage may continue to hold true, it makes little sense in outsourcing arrangements. Let me explain why.

The complexity of an outsourcing arrangement is in many senses unique. That is not to say that other corporate commercial arrangements an enterprise may enter into are not complex. However, an outsourcing transaction is unique in its impact on the enterprise’s internal processes. The way things were done prior to an outsourcing are often manifestly different than the way things are done subsequently. It is a truism to say that changing process is difficult to do. Accordingly, a “stay back” team conventionally helps an enterprise manage its way through these changes. These teams are often comprised of individuals who have deep project management expertise, and are in turn supported by IT and finance groups. Even if the stay back team starts out by managing the relationship in strict conformity to the agreement, over the term of the arrangement (which may span many years), the contract is typically referred to less and less. Instead, decisions on how to handle issues, which inevitably arise in the context of an outsourcing, are dealt with in real time by each party’s business personnel, often with little regard for the processes set up in the agreement. This fluidity to the parties’ relationship can lead to some significant issues.

First, the regimes set out in the outsourcing agreement, which are designed to provide protections for the customer, are not followed. By way of a recent example, a customer and its outsourcing vendor determined that a change was required as part of an outsourcing. The vendor proposed initiating the change as a new service outside the documented change control process, on the basis that it would be “faster”. The customer agreed; speed was desirable to it. Subsequently, there was a disagreement over amounts payable as part of the institution of the change. In the circumstances, the customer’s agreement to permit the change to be made outside the documented change process deprived it of: (i) agreed contractual provisions detailing the allocation of responsibility for costs in the context of changes; and (ii) dispute resolution mechanisms, culminating in mandatory baseball arbitration provisions (which in turn had been drawn up in reference to agreed principles). To the extent that the original negotiation resulted in processes and an allocation of risk that the customer had fought hard to win, moving off the negotiated agreement had the inadvertent effect of depriving the customer of those benefits.

Second, at a more ordinary-course level, the agreement can and should act much like a map through a dark forest. Inasmuch as an outsourcing may last many years, it is not unreasonable to imagine that the parties may well forget who is responsible for doing what, particularly where those responsibilities may change what had been ordinary course behavior for one of the parties. For instance, in one outsourcing, as year-end arose, the customer found it had a certain amount of money left over in its budget. Rather than fail to spend the whole of the budgeted money, the customer decided to acquire certain hardware to replace older equipment forming part of the infrastructure of the business it had earlier outsourced. The problem was that that hardware refresh obligation was the vendor’s, not the customer’s. The vendor had also acquired equipment for the same purpose. To further complicate matters, the customer had chosen equipment different than what the agreement had contemplated in certain material respects. This had the effect of creating unintentional additional costs for the vendor to maintain the equipment, and the vendor needed to be reimbursed for the equipment it had acquired but was unable to utilize elsewhere. So what started as an innocent step taken by the customer to save money resulted in a material cost increase as part of its outsourcing. This problem could easily have been avoided if the customer had but referred to the agreement.

Finally, the propensity for the parties to move “off piste” in terms of their contractual relationship creates a further problem. Relative to any particular issue or change, as parties compound decision upon decision, and act upon act, and in doing so, ever increasingly draw themselves away from the contract terms themselves, the problem that arises becomes one of contractual interpretation. If in these circumstances (which may involve activities between the parties unfolding over months or even years), one party raises its hand and indicates there’s been a breach by the other, and begins to desire to seek recourse, it can be exceedingly difficult to interpret the circumstances against the contractual provisions with any clarity or precision. In situations like this, real ambiguity can emerge as to whether there is recourse, and if so, to what extent. Can the existing contractual provisions be applied? Or, have the parties varied the agreement by their conduct, and if so, what are the present terms? Or, have the parties undertaken activities not contemplated by the original agreement and which are therefore not subject to its terms at all; and if so, what terms are relevant to the arrangements between the parties?

Increasingly, I have come to believe that it is an essential part of outsourcing governance “best practices” to include a lawyer or clerk whose responsibility it is to analyze all proposed changes from the perspective of the contract. Now, this approach assumes that there are provisions in the contract that are helpful to the customer and are accordingly worth adhering to. Assuming that’s the case, our experience in the past few years has been that even if this were someone’s full time job, the costs saved by having that person around to ensure adherence to the contract terms would typically far outweigh the costs associated with paying that person’s salary.

So, the next time you hear someone say, in the context of an outsourcing arrangement, that “a good arrangement between parties is one where the contract can be put away at the end of the negotiation and never looked at again” you may find you have a different perspective.