For Good Outsourcing Contracts, Keep Litigation in Mind

A recent article in the Sourcing Interests Group newsletter that described a litigation perspective on outsourcing relationships is right when it states that a litigation perspective will improve your results with outsourcing agreements. Given that outsourcing agreements are typically long in duration, it is important to craft the best agreement possible. A litigation perspective will help. Why?

Without a litigation perspective, a typical outsourcing agreement is:

  • general
    Since it is impossible to predict every circumstance that may arise, most drafters of outsourcing agreements stick to general terms, broad service descriptions, and generic service level improvement requirements. This is bad because generality results in uncertainty, uncertainty breeds disagreement, and disagreements threaten the stability of outsourcing relationships.
  • full of vague terms
    Such as material breach; gross negligence; willful misconduct; direct, indirect, consequential damages; best efforts; generally accepted standards; and commercially reasonable efforts which sound very legal but which are typically unclear in case law.
  • sparse (or devoid) of communication protocol
    While most outsourcing agreements will contain clauses for dispute resolution, they will be sparse, or devoid, of clauses describing proper communication protocols for communicating, addressing, and responding to issues as they arise. Disputes only arise when issues are not adequately addressed as they arise.

However, with a litigation perspective, a typical outsourcing agreement is:

  • specific
    While the agreement will still contain general clauses for modifying procedures to deal with unexpected situations, it will contain provisions for dealing with situations that can be anticipated in advance, such as a spike in data processing, the inability for the service provider to handle increased order processing, or a change in regulations that restrict a service provider from performing one or more functions. For example, in the first case, if data processing requirements increase beyond a certain threshold in a given month, the organization will pay overtime rates to get it done. If the service provider can’t handle a rapid spike in customer orders, the organization will have the right to bring on a second service provider to assist. And if an unforeseen change in regulations preclude part, or all, of the functions from being performed by the service provider, the organization may cancel the affected parts, or all, of the agreements, without notice and penalty.
  • built on clearly defined terminology
    Instead of just saying that the service provider is liable for “direct damages”, the agreement will say that the service provider is liable for “direct damages, which include but are not limited to the additional cost of securing an alternative service provider” or instead of just saying the service provider is responsible for damages that result “willful misconduct”, which may or may not include a deliberate breach of contract, the agreement will say the service provider is responsible for damages that result from “willful misconduct, which include but are not limited to intentional tortious acts”.
  • clear on communication protocols
    The agreement will contain a communication protocol where the organization can officially notify the service provider of issues that arise, and response protocols for the service provider to officially respond to the issues.

Communication protocols are important as they provide official communication trails and a way to “shape the record”. If an official dispute arises, and goes to arbitration or court, and the organization does not have a clear record of events, that includes correspondence officially notifying the service provider of a(n impending) breach, then its chances of winning its case (and receiving damages) are not good.

Moreover, if the organization maintains a good “real-time” written record of events, that includes official communications that follow the protocol, it has a better chance of resolving the disputes quickly, cost-effectively, and with minimal disruption as a provider is not going to want to risk an official dispute when the client organization has a strong case.

Considering that termination of the relationship likely will cause both parties serious economic disruption, its important to draft the best agreement possible. The best way to do this is to keep litigation in mind and consider how you would prove the elements of a claim if a dispute were to arise as this will lead to the creation of clear and unambiguous clauses.