13 Outsourcing contract clauses to avoid at all costs

By Allan Watton on

outsourcing contractOutsourced relationships can often be punctuated with opportunities for controversy. Having dealt with improving the performance of over 500 outsourcing relationships, evidence continues to teach us that more than 50% of these high-value contracts fail to achieve their expected outcomes for either party.

Why are there so many poorly performing outsourcing contracts?

There are a multitude of reasons as to why we see so many poorly performing outsourcing partnerships – misunderstandings, miscommunications, political agendas and personality misalignment can all result in a problematic or failing/failed relationship. But, if there is one thing that we see time and again as the most common cause of dispute, and most costly to come back from, it’s a written outsourcing contract that is poorly aligned to the business outcomes it is meant to drive. As a result, it has often been poorly negotiated and is not fit-for-purpose.

When I say ‘poorly negotiated’, I don’t always mean that there has been a lack of care taken in its development – though of course this happens as well. Sometimes a poorly negotiated contract can be one that does not consider the future position of its parties clearly enough; is not set up to adapt to their changing needs; or where some manipulation has occurred to unfairly weigh responsibility in one direction or the other. Contracts that are unfairly imbalanced, financially or responsibility-wise, can cause behaviours that are detrimental to the success of the project and to the partnership, so below are a few of the contract clauses where such imbalance can occur and where the unscrupulous may look to adapt the relationship in their favour.

Don’t get bitten by your outsourcing contract

It would be wonderful to imagine that all vendors and clients were honest, reliable and driven by the same goals as you, that quality comes before profit, and clarity before deliberate ambiguity. However, in reality, while most may be led by these high standards, there will always be a few who are less scrupulous. It is because of the existence of such organisations and individuals, and the difficulty identifying them as such, that it is of vital importance that you protect yourself from the possibility of being caught out by one of them.

Then again, it is not just the unscrupulous that you should protect yourself from – you should also be mindful that a lack of time, care and relevant skills in either camp can cause unplanned contractual issues and subsequently project problems. Wariness of such things should be extended to any point when you negotiate or renegotiate your outsourcing agreement.

13 outsourcing contract clauses to avoid

1. Contract Terms that state the buyer pays all costs related to ‘Exit Management’

A blanket ‘buyer pays’ is what to avoid here. Should you wish to transfer an outsourced service to another vendor or bring it back in-house mid-term or at the end of your agreement, it’s important that your exit clauses are in good order. There are many reasons why you might wish to exit your contract, and yes, some of them should rightfully incur full liability for the costs of doing so, but there will be instances when costs should be shared and others where the vendor should take the lion’s share.The question of who should bear the cost of exit management comes down to two simple questions:

  • Do you want to take the service away because they are not delivering on set goals? They should pay.
  • Do you want to take the service away due to internal change (e.g. a shift in priorities)? You should pay.

Clauses relating to exit management should be clear, and they should be fair, but they are all too often ignored. It is equally important that the costs involved in an exit are discussed and agreed upon at the outset and refreshed every 6 months. You would not want to come to the end of your outsourcing partnership and discover a surprisingly large fee request for service transfer in your final invoice from your vendor.

2. Contract Terms that exclude your supplier’s advice and representations

It has been known for vendors to quote for work based only on a client’s agreement to use their standard contract terms. While not always the case, but certainly enough to warrant a mention here, these terms (an ‘Entire Agreement’ clause) can seek to exclude or reduce any liability for advice or representations made by the vendor pre-contract. Be very wary of this, as it is this advice and their assertions that will have shaped your decision to use them and the direction the project is likely to have taken to this point. Contracts should always be accompanied by a bundle of emails, meeting notes, brochures, web materials, and any other documents that passed between you containing information pertinent to the project.

3. Contract Terms that present KPIs that are not aligned to project objectives

Your outsourcing contract should specify the project’s key performance indicators (KPIs) and any bonus payments that will result from meeting or surpassing them. Problems occur when contractual clauses present KPIs that are misaligned with the objectives of the project. In such circumstances, you could end up paying bonuses for transactional outcomes, rather than hitting objectives aligned with the expected project outcome. This should be avoided as it incentivises incorrect action.

4. Contract Terms that limit a client’s remedial capabilities

Clauses are often included in outsourcing contracts that limit a client’s ability to withhold payments, even if the vendor is not meeting their agreed targets.

A strategic supplier may look to ensure that you have no right of set-off (i.e. no right to withhold payment) should they underperform. In theory, this means that you must continue to pay the strategic supplier whilst experiencing poor service. If you then wish for recompense, you’ll need to sue them after the event for appropriate damages.

By means of further protection, some strategic vendors will try to include a provision that if you do not pay them (even in the event of a bona fide dispute), they are entitled to suspend or even withdraw services under the agreement.

It is understandable why a strategic vendor would seek to protect themselves against set-off, but by the same token, you want to protect yourself against a clear lack of performance. Although it’s a bit of a blunt instrument and you should always try to deal with poor performance strategically, in the event performance remediation continues to fail, you should insist that in the case of a bona fide dispute, you can set-off monies owed to the provider in the event of that ‘continued’ poor performance. Additionally, you should ensure that no clause permitting suspension of services in the event of a bone-fide dispute is included within the contract.

5. Contract Terms that do not limit suspension of service

The other side of the remedial capabilities coin provides us with terms that allow a vendor to temporarily suspend or permanently remove their services due to your non-payment. You’ll likely do your utmost to always pay on time, but what if you have a legitimate dispute with your vendor that necessitates a delay of payment until they reach a milestone? Such things should not be limited, as it weakens your position in the relationship.

6. Contract Terms that exclude client’s costs should outcomes not be met

As with the limitation of a client’s remedial capabilities, exclusion of client costs should the project go wrong should be handled in a fair and reasonable way. A blanket exclusion through contractual terms would be unreasonable, but also so would a blanket inclusion clause. It would be most sensible for different scenarios to be reviewed and quantified, then included within the contract as reasonable assessments of loss under specific circumstances; therefore, liability will be limited, but reasonable costs will be reimbursed.

7. Contract Terms that denote service credits as THE remedy for poor performance

Service credits are the store vouchers of the outsourcing world, and everyone prefers cash when they take something back. While service credits may be a legitimate tool for ensuring productivity levels, if the contract is worded in such a way that service credits are the sole and exclusive remedy in the case of consistent under-performance, and those service credits are capped at a low percentage of the contract value, its value as a means of disincentivisation is diminished drastically.

8. Contract Terms based on ‘Agree to Agree’

When it comes to points of contention in contract negotiation, a vendor will often suggest that the clause in question be “put to one side” so that it does not hold up the signing of the agreement, on the basis that the details will be ironed out a later date.

In reality, you should be able to spot the inherent danger under such circumstances. If the issue cannot easily be resolved in the first instance, there is no reason to suppose it will be easily resolved in the future. Furthermore, it will be really difficult (read: legally expensive-albeit usually possible) to hold the supplier accountable for issues relating to a clause that you never formally agreed. If you always avoid any “agree to agree” arrangements in the first instance, it will save you a whole world of pain in the on-going management of the relationship.

9. Contract Terms that exclude your costs if things go wrong

As with the usual rights of set-off, it is reasonable for vendors to limit their liability on projects. The key is in ensuring that any limitation of liability is both reasonable and fair. A limit of the price paid is, for most major projects, not equitable.

Therefore, it is vital under such circumstances that you have a genuine pre-estimate of losses calculated in the event that the project doesn’t deliver your expected outcomes in specific areas. You can then be confident that the losses you incur are reasonable, and that the provider understands what that limit of liability is and they can make their own risk assessment. Undertaking appropriate pre-contractual due diligence on the service user expectations through an agreed process will usually help the supplier to gain much deeper knowledge of your expectations, and in turn, understand how to reasonably limit its own liability by delivering to the client expectations.

10. Standard Contract Terms for additional project work

Most quotes (bid responses/work orders) you receive from vendors you have already engaged with will state that the price is based upon standard contract terms, rather than the contract you have negotiated. Such terms typically exclude all of the advice and requirements you expect to achieve, which can prevent the vendor from being held accountable for the fitness for purpose of the new project.

The key is to make it clear to your strategic vendor that there are certain Heads of Terms that must be incorporated into all future projects/work orders. Additionally, you should advise them that any work orders based upon standard contract terms, rather than the terms you have negotiated, will not be accepted.

11. Contract Terms that don’t have ‘Agreed Cooperation’

When something goes wrong within a service partnership, your vendor may be quick to blame your internal team for not adequately supporting them. If, at any point, you don’t do as they ask, they may use it as an excuse for not being able to meet the project’s goals.

However, the real question is this – should you actually be doing what they are asking of you? The key to answering this question is to ensure that your roles and responsibilities are clearly delineated in the contract according to the advice you have received from your vendor. This being the case, you can reasonably claim that the contract reflects a ‘fair and equitable’ balance of roles and responsibilities. It may also be beneficial to consider the creation of a ‘relationship charter’ which enshrines the core principles of the relationship for all to refer to in tough times.

12. Contract Terms that transfer risk on ‘Testing and Acceptance’

Outsourcing contracts that have an element of technology service delivery associated with it should have clear provisions around satisfactory quality, fitness for purpose testing and acceptance and the duties on the provider to have tested their deliverables to prove quality and fitness for purpose prior to UAT (User Acceptance Testing). Often the project documents will seek to overwrite these provisions and push responsibility for testing, quality and fitness onto the client. Keep a close eye on that – it fundamentally alters the rules of the game. You can put reliance on ‘implied expert responsibilities’ of your vendor to realign the balance in a fairer way, but better to avoid this if possible and be clear in the beginning.

13. Contract Terms that assume all changes are chargeable

What can you do if your change control process has become unmanageable? Should every change be chargeable, or is there an argument that some are within the scope of the agreement and others are so small a change as to not warrant a charge? Ensure that your agreement is clear on what is and is not chargeable, or fees could start to escalate out of control.

If it is a case where your outsourcing vendor simply hasn’t completed appropriate due diligence on your expectations and, therefore, hasn’t provided a critical friend challenge on your requirements, it is likely a number of misunderstandings may have been lost in translation. However, note that your vendor, if it represented itself as a specialist in its field, cannot use the excuse that you didn’t tell it something as a reason to charge more. If the vendor did not undertake appropriate due diligence on your requirements/expectations, then it will usually become responsible to remedy any misunderstandings at its own cost, rather than yours. Recent case law has helped to clarify the position on this.

Hence, having an appropriate pre-contractual due diligence process undertaken by your vendor that, (a) clarifies your understanding of what you are aiming to achieve, and (b) challenges your expectations and requirements, means that your vendor has the time and visibility to provide you with much better advice from its experience to ensure you have a fit-for-purpose solution before you sign on the dotted line. In this manner, all material changes are identified ‘upfront’ through the diligence process and, therefore, lack of clarity over future chargeable changes is very much minimised.

Conclusion

A written outsourcing agreement between ‘partners’ can say so much more about the parties than the words alone convey. Each side’s desire to weight clauses in their commercial favour, and the degree to which they insist on this, offers a good indication of where the relationship may be headed in the future. Mutual trust and respect can only be achieved when a contract, that suits everyone’s needs, is written in plain English and focuses more on the goals of the project, than the aspirations of one side of the agreement.

Outsourcing contracts need to be clear and effectively communicated, and they should always be adapted to the reality of the relationship, the project and the environment in which the objectives of the project are to be employed. Every time that the agreement is assessed and updated there is an opportunity for one or both sides to build on commercial trust or lean more towards selfish goals. Always be wary, always ask for clarity, and always be mindful of the motivations of those who create or adapt your agreements.

To get the best results, insist on a ‘fair’ agreement, one that supports the needs of all concerned, that encourages innovation and will effectively steer the relationship. Become proficient at recognising ‘issues’ with clauses, whether in standard terms or in those you are asked to sign, and be demanding in your need for clauses to be unambiguous in both tone and content.