Wouldn’t it be nice if client-vendor relationships always followed a clearly defined path with all parties focused on doing their best to live up to the business outcomes they agreed to at the outset?
I can almost hear you nodding and sighing with wishful thinking, but, as we all know, in the real world, major contractual relationships are quite often rife with miscommunication, hidden agendas and ambiguity. In addition, there are always some who will believe that if they bury their heads in the sand for long enough, it’ll all work itself out in the end.
But when things don’t work themselves out, or when relationships or service levels degrade beyond the point of no return, you may well find yourself in a conversation with your legal department about the pros and cons of early outsourcing contract termination, or part-contract termination due to irreconcilable differences. And that’s when it’s important to know how to influence your exit fee rights and obligations in order to ensure that you do not incur liability for huge exit fees.
Considering Early Outsourcing Termination? Evaluate Carefully
This is a very difficult area. Taking an early exit from an outsourcing contract can cost you a considerable sum and consume a significant amount of your time, and many will be concerned that it could have reputational implications as well. In other words, the stakes are high so you need to make the right decisions about how best to proceed.
When we are asked to review such matters, we generally have three key goals in mind:
- To evaluate whether early termination/exit from all or part of a service is warranted.
- To evaluate whether the exit/termination should come at a significantly reduced cost, no cost, or (where performance by the vendor has been particularly poor) whether rebating service fees to the client is warranted along with free of charge transitional support to bring the service back in-house or on to another, more capable vendor.
- To ensure that when the end goal is the part-termination of a contract, that a strong working relationship can be restored between vendor and client beyond settlement, moving forward in a more positive, aligned and innovative way.
In order to determine whether exit fees can be minimised, you often have to look beyond the express wording of the contract to:
- The pre-contractual ‘expert’ (capability) representations the vendor made towards you (although these do not necessarily have to be formally captured in the wording of the contract or schedules)
- The behaviours of both parties during the delivery of the services and to what extent each party completed their respective delivery obligations, taking into account the vendor’s ‘expert’ responsibilities
The Trouble with Exit Fees
In a perfect world, written contracts would be tailor-made to clearly reflect what the client and the vendor have to do to achieve the correct business outcomes for both parties, including a road map to the most effective solution, should disputes arise. Unfortunately, many written contracts in these complex circumstances are ambiguous, confusing, and often even contain clauses that explicitly contradict one another.
This leaves the door well and truly open for an unscrupulous vendor to claim rights to exit fees where none exist, overestimating these fees, or overcharging you for the privilege of letting you out of the contract early. Because the figures involved often run into many millions of pounds, we feel quite strongly that more clients should be made aware of the ways in which they can encourage a vendor to ‘prove’ their claim to these exit costs. With this information in hand, at least you will have a baseline from which to negotiate something sensible between you, dependent of course on whether you choose to exit early for ‘convenience’ or due to poor vendor performance.
I should point out that I believe there to be many honourable vendors in the market and, conversely, I also believe that there are clients who will attempt to skew the facts in their favour when it comes to blame for the breakdown in relationships. However, the point is that there exists an opportunity in many complex vendor relationships for the early termination and exit fee clauses in a written contract to be abused.
Will You Exit for ‘Convenience’ or Due to Poor Performance?
If you are considering ending such a relationship early, your first decision should be whether you wish to exit for ‘convenience’ or for poor vendor performance, as this will govern how you handle the conclusion to your relationship with your vendor.
At the same time you must also decide whether you wish to sever all ties with the vendor or simply exit from certain defined services, as it may be the vendor is performing well in some areas but not in others, despite your efforts to work with them over a protracted period to improve their service delivery. This decision will be critical to the way you will proceed with such a termination.
An exit for ‘convenience’ is when you decide that you wish to exit the relationship because it no longer aligns with your organisational objectives, despite having first tried to realign the services and vendor performance to meet them. In these circumstances, you don’t believe the vendor is under-performing per se; it’s just that the service, vendor or relationship is no longer fit for purpose for where your organisation is now heading.
There is another situation, however, where your vendor may well not be performing, but you still decide to terminate and exit for ‘convenience’ having considered the potential cost, time implications and conflict you will have to deal with in proving the vendor has not achieved its agreed business outcomes are not worth the extended arguments that are likely to ensue.
You may think that in the above situation, it would be easiest to simply pay your vendor to, well, go away. And if that is your preference, you can – but this is often a very expensive option. In these circumstances you will need to sign a confidentiality agreement that requires you to keep quiet about the real reason for your exit from the relationship, and thoroughly review the relevant clauses in your contract to calculate what you believe to be an accurate and fair exit fee. This calculation will often differ from the vendor’s, requiring you to decide how much of a premium you are prepared to pay to settle the situation quickly and out of court.
An early termination for ‘default’ or ‘poor performance’ is when you decide to hold the vendor to account for its poor delivery record, having already tried every ‘reasonable’ process to help guide them to improve their service performance. There will usually be provisions in a written contract that outline how early termination fees should be calculated in the event that the vendor is not achieving its agreed outcomes in the relationship.
Despite the above, it would be fair to say that the vast majority of written contracts contain ambiguity in their early termination clauses, which can result in exit fees being inflated by some vendors. It is equally fair to say that should you decide to assert your rights to minimise your exit fee obligations due to the vendor’s poor performance, more often than not, evidence will be available that helps you achieve this quickly, fairly and equitably.
6 Questions that Could Save You Millions in Early Termination Costs
Over the years, dealing with in excess of 500 problematic outsourcing and larger technology/software vendor relationships, we have established clear and effective solutions for when, despite your best efforts to help the vendor improve its performance, you need to terminate the relationship early because it simply isn’t working.
As part of this practical education, we have found that six questions have consistently helped us in uncovering ways to ensure that any early termination fees (if they are legitimately due), can be fairly and equitably reduced.
Although we make reference to what a court is likely to consider and look for in a case, these matters often do not get to court. Nor should they. Most times, these issues are a matter of fact and evidence, and arming yourself with this knowledge, gathering all the right information you’ll need to prove your case, means you are in a much better placed to pre-empt and answer any arguments a vendor or its lawyers are likely to put forward. And because you are approaching this from a more informed position it will be easier for you to determine whether their arguments have merit or not. Although there are other factors to consider, the six key questions to ask are:
1. What ‘expert’ representations did the vendor make during the bidding process?
If a vendor’s representations regarding the results, services or innovations they would achieve were fundamental to your decision to hire them, an appropriate court will usually take these into consideration alongside KPIs and explicit service level requirements to determine whether vendors are falling short of their service delivery obligations. There are many examples where vendors have achieved their written contractual KPIs, but the courts have ruled that they were not meeting performance expectations because of the pre-contract representations they had made – even though these representations were not expressly written into the contract terms.
2. To what extent have these representations been fulfilled?
The courts will often look at the vendor’s efforts to deliver on these representations and determine how far they are from achieving promised business outcomes. If a court finds that the vendor is not delivering to agreed and reasonable standards (based on their ‘expert’ responsibilities, not just what is detailed within the written contract terms), they will be accountable to put things right and elevate standards to these levels at their own cost.
3. How do the relevant clauses for termination, exit charges, and the contract as a whole align with those representations and expected business outcomes?
If the contract was drafted clearly, with a significant weighting that aligns to the business outcomes of both parties, then the process documented for early termination and exit (whether for convenience or poor performance) offers clarity over the costs and process for exit. But, as in many cases, if the contract is not drafted clearly, it is important to view the contract terms in context with the ‘expertise’ the vendor said it had. This will help the interpretation of the terms and costs where ambiguity previously reigned.
4. How clearly did you communicate your own expectations / objectives / outcomes from the service delivery?
It is important to sanity check, ideally with an external critical friend or knowledgeable and dispassionate colleague, the documented business outcomes and expectations you shared with the vendor. In this way, you will hope to identify whether you really were clear about your expectations and if not, whether the vendor exercised its ‘expert knowledge’ and its ‘duty to warn’ you of any instructions or goals that were either ambiguous, unreasonable, or that it would be unlikely to meet, during the bidding/tender process.
From this you’ll be able to assess whether your vendor could have, or should have done anything differently to improve the service delivery process and, therefore, whether minimising early termination/exit fees is a legitimate and equitable option for you both.
5. During the tender or bidding process, did the vendor give clear ‘warnings’ about any service delivery benefits they would ‘not’ be able to achieve and to what extent did you accept them, ignore them or rely upon them?
In many ways, this is a similar point to the previous one, but relates more to your own behaviour as a client, as to what actions you took, subject to whether the vendor warned you or not about the issues below.
If the requirements were ambiguous, did the vendor warn you about the ambiguity? If so, did you provide factual information to help clarify the vendor’s questions (which the vendor accepted), or did you simply accept that ambiguities existed, despite the warnings from the vendor, in the expectation that they would get ‘sorted out’ at some point in the future?
If you ignored or dismissed warnings from the vendor, then there would be other challenges to address if you are still thinking of terminating early for poor vendor performance. Conversely, if you acknowledged and addressed the warnings, and reflected these in your behaviour throughout the time you managed the vendor in delivering your services, but poor performance from the vendor still ensued, then you may be on very strong ground to be able to terminate the relationship early, with minimal or no exit costs. In many cases, you may even be entitled to a refund of service charges, though this would be subject to the business impact of the poor service delivery from the vendor.
6. To what extent have both parties’ behaviours during service delivery been aligned to the business objectives and has the governance you have operated escalated matters in an appropriate manner?
This point, although related to the two previous questions, focuses on how the contractual side of the relationship has been managed and how or whether problems/challenges have been escalated in line with the written contract terms.
These terms should be structured to clearly outline what you and the vendor are supposed to do, and by when. They should also be clear on the procedure to follow when performance issues need to be informally and formally escalated to ensure that your business outcomes continue to be achieved. But what if an issue is not mentioned in the written contract or specifications? Worse still, what if the escalation process outlined in the written contract would clearly result in unnecessary delays and costs for the service issues you are experiencing?
In these situations, it can be complex to unravel the legitimacy of who is accountable if the escalation process in the written contract is or is not followed. It is usual for the courts to look at each parties’ historical behaviour during service performance and whether that aligns to, (a) the business outcomes anticipated by each party and, (b) whether the behaviour aligns to the written contract. Often the courts will use the old adage of ‘actions speak louder than words’ to determine where accountability should lie for poor performance.
If these six questions are asked by a critical friend, they are sure to provide visibility that will help to inform you whether to terminate early for convenience or for poor performance. They might even provide transparency as to whether you should be terminating early at all.
Be Frank – Your Answers will Help you Self-Analyse
The answers to these six questions will help you to self-analyse whether you are being true to yourself; in other words, being honest with yourself in terms of ensuring you have the right information to hand to make an informed decision.
You may well not like the answers, but honest, factual and frank responses to these six questions will likely save you millions from taking the wrong decision, or negotiating a bad settlement, when a much more equitable and evidence-based process for getting to the right decision is available.
In one such example of where this process was used, a client of ours saved themselves tens of millions of pounds when early termination was contemplated and exit fees calculated correctly when taking the above six questions into account. In other more moderate examples, typically between £1m – £10m in early termination costs have been saved just by using the correct application of these principles.
Early full or part termination of complex relationships can be a time-consuming, costly and traumatic experience if not handled correctly. Though, despite what your vendor may suggest or demand, and contrary to what your written contract might say or imply, exit fees for early termination are not always as significant as you might think they will be. There are tried and tested ways of minimising these costs and of accelerating the whole process of moving on from your legacy vendor, if in fact that is the most appropriate action to take.
If you are experiencing any of the issues noted in this article, please feel free to get in contact with us and we’ll be more than happy to discuss sanitised examples of how other organisations have been able to reduce their costs when considering whether to terminate a complex vendor relationship early.
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