Central to any outsourcing deal is the contract, and for that the best legal advice is necessary. The agreement must, among other things, define the scope of the services to be transferred to the supplier, state which elements will remain with the customer, set out the responsibilities of each party, comply with all financial regulations and laws, safeguard employee rights, ensure the pricing is right (for both customer and supplier) and set out clear termination clauses.
Other contractual issues to consider are document management, protection of intellectual property, taxation, business continuity and disaster recovery. In short, it is a legal and regulatory minefield that can explode if you put a foot wrong.
Specialist input required
John Bennett, senior counsel, outsourcing, at ABN AMRO, which has entered into many outsourcing contracts, including one last year worth €1.8bn (see article on page 6), says that outsourcings are complex transactions requiring specialist legal input in a number of areas, including commercial contracts, tax and human resources. “Because of this complexity, it is mandatory for the business to engage the ABN AMRO legal function whenever an outsourcing is being proposed,” says Mr Bennett. “In turn, our legal function has established a specialist sub-panel of external law firms to advise on outsourcing transactions.
“Internally, we have recently established an Outsourcing Practice Group, which I chair. It is a team of six lawyers with representation from each of the regions where ABN AMRO has a presence. The group provides an excellent means of sharing know-how between lawyers and ensuring best practice is applied consistently across the group.”
What are the main things to get right when drawing up a contract? “Ask this question of six lawyers and you will receive six different answers,” he quips. “My approach is to draw an analogy with getting married. This means making sure you are well protected should there be a divorce. In other words, getting the obvious legal stuff right, like liabilities, indemnities, termination consequences, etc.
“Lawyers are well within their comfort zone dealing with these issues. But going beyond that, you need to think what is most likely to lead to the divorce in the first place and do all you can reasonably do to prevent it. This means getting your service descriptions and service levels defined clearly in the contract. Deficiencies in these areas are the most common reason for disputes in outsourcing deals.”
Like the relatives of the bride and groom, the financial regulators have to be kept happy, too. For ABN AMRO, with activities in more than 50 countries, this is a major task.
“Ensuring compliance with each of these under the umbrella of one contract is often difficult,” says Mr Bennett. “To ensure we are compliant, we will engage local legal and compliance departments so that any local requirements are captured appropriately in the contract. An alternative way around this problem has been to enter into local service agreements, which sit under a global framework agreement and which allow us to reflect any local legal, regulatory and tax requirements in a separate agreement.”
Rare terminations
Bank outsourcing contracts are rarely terminated early or are subject to litigation between bank and vendor, partly because both parties have too much reputation to lose, partly because contracts are well-drafted and partly because the right outsourcing partners are chosen in the first place.
“Exiting an outsourcing contract early is always going to be done reluctantly given the time and effort usually taken to embed the supplier into the organisation in the first place. The idea that just ‘changing horses’ can make your problems go away is foolhardy. Of course, there are times when the service provided by the chosen supplier is just so bad that there is no alternative to getting out, but it’s rare for there not to be issues on both sides,” says Mr Bennett.
“As for litigating, this is almost always going to be a precursor to termination, so for the same reasons is often equally unpalatable. That leaves effective contract and relationship management as the only really viable options to ensure the relationship gets back on track.”
Top-notch lawyers
Andrew Moyle, a partner at US law firm Latham and Watkins, specialises in IT and business process outsourcing for financial services companies. “We act principally for the outsourcing customers rather than the suppliers,” he says. “Many clients don’t need advice from us at the outset because they have been doing outsourcing for a while and have relatively sophisticated dedicated legal functions internally.
“But all of them recognise that where deals are significant, in size or strategically, it’s difficult to run the projects themselves so they call in external help. At the other end of the spectrum, there are clients that have not done much outsourcing at all and need external legal advice from the start.”
It is important for it to be clearly articulated and understood between the parties exactly what services are going to be outsourced, and what will remain the customer’s responsibility. This can be time-consuming because the customer does not usually have the information documented because it has been performing the functions itself.
“Once it is clear who is doing what, everything else flows from that: you can price it, put in performance measures, determine what the risks are for each party, and work out what the cost of doing the deal is, including the cost to the bank of buying the service and managing the deal,” says Mr Moyle.
“The bank often needs a significant retained organisation to deal with the supplier. It’s not like selling a business. With outsourcing you dispose of it, and then buy it back,” he says.
Key principles
Laurence Jacobs, head of the European outsourcing practice at US law firm Milbank Tweed, advises customers and suppliers in the financial services sector. Clients have included Barclays, HSBC, EDS, JPMorgan Chase, Lloyds TSB, RBS and Unisys. The firm also advises fund and asset managers on how to outsource aspects of their administration to banks.
“The way people approach outsourcing has become too complicated but there are six key principles,” says Mr Jacobs. “The first is ensuring the scope of the services is properly understood by both parties; second, ensuring that the outsourcing bank protects its customers’ interests; third, protecting the supplier; fourth, establishing who is liable for what if things go wrong; fifth, setting out clear terms for termination; and sixth, dealing with the regulatory compliance issue.”
Deals that go wrong
According to Mr Jacobs, when deals go wrong, it is usually for one of two reasons: either there is a change in management strategy, as there was when JPMorgan Chase merged with Bank One, which led to “the combined management deciding that they wanted to bring services back in-house”; or “suppliers have got ambitious about the services they can deliver”, especially in business process outsourcing, though this is less of a problem now.
Richard Lister, lead co-ordinating partner at UK law firm Freshfields Bruckhaus Deringer’s outsourcing practice worldwide, has worked for ABN AMRO, Goldman Sachs, Compass Group, Deutsche Bank, Lehman Brothers and Hewlett-Packard. “We do 55 to 60 transactions a year for financial institutions and non-banking clients, but most are banks,” says Mr Lister. “They were the fastest adopters of outsourcing and are still the largest users. Of those transactions, in about 60% of cases we act for the customer and in 40% for the supplier.
“For our clients it’s a mature activity, so by the time a bank comes to us for external advice, they have already built the business case for the deal and will have a contract template. The key thing to get right in an outsourcing contract is the scope. The vast majority of disputes in outsourcing relate to scope, where somebody didn’t define the service exhaustively enough in a commercial, rather than a legal, sense.”
People liability
The principle liability for the outsourcer is “the people liability”, says Mr Lister, because staff are made redundant or their employment is transferred to the supplier. It is also important to draft a contract in anticipation of it ending so that it is clear “how it will be transferred back to the bank, transferred to another supplier or be renewed with the existing supplier”, he says.
“Very few contracts are terminated early or reach the stage of formal litigation. Contracts are tightly written, plus both parties want to avoid the bad publicity. There are not many reported cases of outsourcing disputes. Yes, regulatory breaches as a result of mistakes by the supplier happen, and operational errors are made. The result is claims for loss and breach of contract, but they are settled without resorting to legal action and are not reported,” says Mr Lister.
Rob Petershack, a partner at US law firm Michael Best & Friedrich, says the legal risks of offshoring are particularly high. “This is primarily the result of conducting work in two different countries with conflicting legal systems. Not only do the intellectual property laws differ from country to country, but a company must also take into consideration the nature of the judicial system, the various local laws and the rules that would be imposed if the offshore company becomes bankrupt.
“In addition, the company should ensure that an accepted dispute resolution procedure is expressly set out, including where the case would be filed should a conflict arise.”
For any banker involved in outsourcing, no matter how experienced they are in this area, the message is clear: get a good lawyer.
