Tuesday, November 30, 2010

An Attitude to Outsourcing Agreement Disputes (Not a Course of Action)

The problem surfaced recently in a casual, hallway conversation with an in-house colleague. The customer, my colleague’s employer, had contracted with an unnamed IT service provider for significant software development services but now, some months into the contract, was encountering difficulties. The software developer was not performing and the customer didn’t know what to do. In-house counsel realized just how costly, time-consuming and disruptive it would be to seek to terminate the contract for the service provider’s breach. Yet, at the same time, counsel didn’t see an obvious path to a resolution. Should the customer just cross its fingers and hope that the issue would be resolved as the parties worked through the normal project and contract governance procedures? Should the customer try, outside the contract governance procedures, to renegotiate the agreement? Was it time to invoke the contract dispute resolution process?

I thought about that casual hallway conversation over the next couple of days, trying to work out in my own mind the best way through a very large issue in an outsourcing agreement (about which, as a result of the exceptionally discrete statement of facts, I admittedly knew almost nothing). After some thought, and recognizing that with so few facts the best one can do is suggest an attitude to resolving the issue rather than a course of action, what I should have said to my in-house colleague is this:

I. Dispute Resolution

There are clearly times in an outsourcing relationship when the parties need to invoke the dispute resolution process, e.g. if the other party is not paying attention to or remedying contract or performance issues, is in material breach of its contractual obligations (which need not be repeated breaches – one can be enough), has inflicted serious damage on the other or is acting fraudulently. However it is probably not the right time to do so if an issue has just surfaced or the parties have just started to meet to work out how to respond. Invoking the dispute resolution process will change the dynamics of the outsourcing relationship: it will transform cooperative, problem-solving sessions into acrimonious for-the-record meetings orchestrated by counsel in anticipation of litigation that will paper the file but not contribute to resolving the problem. In such circumstances the parties focus on building their case, not resolving the problem, because in the midst of dispute resolution, what’s right for the dispute matters more than what’s right for the problem. And even if the outsourcing relationship survives the resort to dispute resolution, the trust and cooperation that is fundamental to a successful outsourcing will likely have been significantly if not irreparably damaged by the process.

While the initial stages of dealing with a problem may not be the right time to invoke the dispute resolution process, that doesn’t mean the dispute resolution process should be ignored. It should not. The customer needs to understand its situation and, before proceeding further, the customer should review the contract carefully to ensure it understands how the dispute will be treated under the agreement, the remedies available to it (or the liability to which it is exposed) and any limitations and limitation periods affecting the dispute. If the customer understands its legal situation, it will be able to use this knowledge in discussions around the problem. It just is not clear that the right first step to resolving serious contractual issues is to invoke the dispute resolution process.

II. Contract Governance

There are almost always benefits to leveraging the governance procedures documented in the outsourcing contract:

• Presumably, the procedures were prepared by the parties with the specifics of the outsourcing agreement in mind: at one time at least, the parties thought they would be adequate to deal with the operational issues arising under the outsourcing agreement.

• The customer and the service provider can apply the documented governance procedures to trying to resolve their problem, not spend time working out new processes to resolve the issues.

• Using the existing governance procedures may allow the parties to limit the discussions to a single issue or irritant (if it is in fact such) rather than triggering a review of multiple and possibly time-consuming issues.

• There is probably an escalation procedure already built in to the governance procedures, perhaps from the regular “joint governance committee” to a defined “executive committee”.

• Using the existing governance procedures will likely not require the parties to incur significant additional expenses.

That doesn’t mean however that the regular governance processes will be adequate to deal with every issue that comes up. Many of the contract governance procedures I have seen have concentrated on dealing with issues arising in the normal course of day-to-day operations. Such procedures are unlikely to be appropriate to resolve very large or material issues (such as those that can be involved in the failure of a software developer to perform its application development responsibilities in a timely fashion). That is because the larger or more material issues will likely require the parties to deal with a coterie of complex questions, e.g.:

• Who needs to be notified of the issue?

• Are the discussions without prejudice?

• What happens to interim agreements if the issues are not resolved?

• Do discussions under the existing governance procedures satisfy any steps in the dispute resolution processes?

These are not the sort of questions that are typically addressed as part of the governance procedures defined in an outsourcing agreement.

III. Custom Processes

Faced with very large or material issues, the parties may be well advised to ignore the contract’s defined governance procedures and to develop customized procedures to deal with the issue at hand. The customized procedures will allow the customer and the service provider to address the issues identified in the previous section as well as to discuss all of the other questions that should be considered such as:

• Who should be involved in the discussions from each party?

• Should one of the parties deliver a notice of default?

• Are the parties deemed to have waived any claims to damages or otherwise by engaging in the negotiations?

• Will the parties attempt to resolve all of the issues affecting their outsourcing relationship, or only the immediate issue at hand?

• How will the results of the discussions be documented? In a term sheet? By letter agreement? By a contract amendment or in a restated and amended agreement?

• Will the parties sign mutual releases at the end of the renegotiations?

Of course, it will require some time for the parties to agree on what these customized procedures will be. However, for larger disputes at least, this may not result in any actual delays: at the same time as the parties are working to define the bespoke procedures for the issue at hand, they can be undertaking the reviews and investigations that are likely necessary for them to prepare for the actual negotiations.

Much more analysis around many more questions is required to decide the best approach to resolving a dispute. What outcome does the customer hope to achieve? How is the service provider likely to respond? Are there any time constraints? The point, perhaps, is that the customer should think as much about these questions and about how to resolve the dispute as about the dispute itself.

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