By Alastair Marum, Senior Commercial Counsel, and Bridget Connolly, Senior Commercial Counsel, BT Americas Inc.
Abraham Lincoln has been quoted as saying, "If I had eight hours to chop down a tree, I'd spend six sharpening my axe" - indicating the importance of thorough preparation. Preparing for contract negotiations is no exception to this truism. To negotiate effectively, attorneys need to scrutinize the implications of each provision before endeavoring to hammer out the details of the contract. By the same token, in their preparations, attorneys need to consider that a successful transaction must be a 'win-win' for both parties. This article provides some general guidance on the top ten terms to prepare to get right in a complex transaction.
1. Transition
In many services contracts there is a period of time known as the transition period where the contracted service is moving from the Customer or its legacy vendor to the new Supplier. The Parties' respective obligations during transition are frequently not well documented and can become the source of disputes between the Parties. When drafting transition provisions, it is important to also recognize that a successful transition is dependent upon certain Customer activities ('dependencies'). Once these dependencies are agreed, it is reasonable for the Supplier to obtain relief from its affected obligations when a Customer dependency is not met. Documenting and discussing these Customer dependencies and the associated Supplier 'relief' helps ensure the Parties' relationship starts off on the right foot.
2. Beware of the Definition of "Services" that Expands Scope Commitments
Traditionally, the scope of contracted Services is set out in a Statement of Work ("SOW"). This approach is however often an issue for Customers in complex transactions, particularly in the context of outsourcing transactions where 1) Customer personnel are transferred to the Supplier and the Customer expects those transferred personnel to continue to perform the same functions/activities, regardless of whether these functions/activities are identified in the SOW, and/or 2) services/functions that are not identified in the SOW are necessary or customary for the provision of the Services. Conversely, the Supplier is eager to avoid unknown scope creep and hence unbudgeted cost impacts. A potential solution for these two issues is a definition of Services that limits the functions/activities not identified in the SOW to just those "required" to perform the Services.
3. Service Levels
Service levels define a minimum measurable level of service commitment (e.g. fault resolution time). When drafting service level provisions, it is important to establish a clear methodology for setting, calculating, changing, and improving service levels. Some key considerations:
- Are the service levels objectively measureable? Are the service level penalties reflective of the impact to the Customer? Does the design and pricing of the Supplier's service support the proposed service levels?
Obtaining agreement on these questions can help the Supplier focus resources on the services that really matter for a Customer.
4. Due Diligence
Walk in takeover ("WITO") transactions in particular require a solid understanding of the Customer's legacy environment. A post-contract validation ("PCV") provision is typically an acknowledgment that the Supplier may have received inaccurate and/or incomplete information from the Customer (e.g. number of supported assets) and that there will need to be a period of time after contract execution when these inaccuracies will be 'trued-up'. Typically, Customers don't want Suppliers to have a 'true-up' right, as it undermines the certainty of the business case the Customer used to get the contract approved. As a result, Customers will typically push back on any PCV provision and instead insist upon contractual protections that prohibit Suppliers from changing pricing or services due to any inaccuracies or omitted information. This is a real risk on the Supplier when the contract is fixed-price or WITO. However, in fairness, the transaction should be a good deal for both parties. A bad deal for one party is a bad deal for both parties. If complete and accurate pre-contract information is not available to the Supplier, the Customer should not expect the Supplier to risk entering into the agreement without a reasonable PCV provision. The PCV provision should establish rights and responsibilities on both parties, acknowledging that the PCV could result in either increased or decreased charges.
5. Benchmarking
Long term contracts frequently have a benchmarking provision to ensure that the contracts' terms (i.e. pricing, service levels, etc.) remain competitive with market rates. When negotiating a benchmark provision, it is important to recognize that benchmarking is not just a price review exercise. Factors such as the customized nature of the 'scope' of Services, the service levels, the obligations to update technologies, and/or other cost-saving and cost-control contractual obligations are all material elements that must be evaluated and normalized in a comparison with other contracts in the benchmark process. Some key elements of any benchmark provision include:
- Is the Benchmarker a recognized and qualified independent third party? Does the Supplier have the right to approve the selection of the benchmarker? Are there limits on when the first benchmark can be performed (e.g. not within the first 2 years of the contract)? How frequently can a benchmark occur during the contract term? Is the Supplier sharing the expense of the benchmark with Customer? Are there sufficient normalization factors to account for differences between the comparison group and the benchmarked contract? What is the benchmark measurement target (e.g. is it top quartile or mean of comparison group)?
Adequately addressing these questions in the contract can assist the benchmarking process and minimize the potential for disputes between the Parties.
6. Be Mindful of the Categories of Information to be Safeguarded
The "Data Protection" section of complex transactions typically cover three primary categories: 1) Confidential Information; 2) Customer Data; and 3) Personal Data. The linkage among these terms has a significant impact on each party's rights and obligations. For example, a definition of Confidential Information might be:
"In the case of Customer, "Confidential Information" also shall include Software provided to Supplier by or through Customer, Developed Materials, Customer Data, Customer lists, strategic plans, trade secrets,...or other information or data obtained, received, transmitted, processed, stored, archived, or maintained by Supplier under this Agreement."
This definition includes terms that have their own definitions, each of which must be considered for a full understanding of the obligations. For example, "Customer Data," could include information that that should be excluded from the more onerous requirements of confidentiality. Likewise, "Personal Data" is typically a subset of Customer Data. Be mindful of this relationship whenever these terms are used.
7. Ownership of Materials
A term like "Materials" typically identifies a laundry list of intellectual property such as software, design documents, analyses, methodologies, reports, and the catch-all, "other proprietary rights." Irrespective of the type of transaction being negotiated, many Customer attorneys have a one-size-fits-all approach in their contract templates that establish ownership rights for the Customer of any Materials created by the Supplier during the Term. Ownership, however, should be considered in the context of the transaction.
- Is the Customer paying the Supplier to provide services or to create Materials, or both? To what extent will the Customer have use for Supplier-created Materials after the agreement has ended and if so is it included in the price? Could agreement on the transfer of ownership of Materials at the beginning of the agreement have unintended consequences for the Supplier at the end of the agreement? Can specific Materials that Customer wants to own be identified upfront as an alternative approach?
The answers to these types of questions should be considered when negotiating the intellectual property section.
8. Thorough Assessment of the Indemnification Clause
Most contracts for complex transactions include numerous and onerous indemnities. Eliminate or cap these indemnities where practicable, and ensure that the indemnitor is in the driver's seat, all subject to your client's overall risk appetite. Also, check for possible duplicated indemnification exposure. For example, the list of indemnities could include claims for both breach of the "Data Protection" section, and claims for breach of the "Compliance with Laws" section, which would typically include data privacy laws. Specificity will help avoid the same or similar claims being brought under different indemnities.
Exclusivity of claim rights should also be addressed. Without exclusivity, the indemnitee has the option to also pursue its common law remedies, which may not be subject to any of the negotiated limitations of liability. From the indemnitor's perspective, an indemnification provision is far riskier if it is not an exclusive remedy. Also, given that the duty to "defend" is a separate duty from the duty to "indemnify," control over the defense, including the right of settlement, should be addressed, together with a requirement for prompt notification of any claim in writing. Finally, include a duty to mitigate damages, as some U.S. courts have found no such duty on indemnitees.
9. Limitation of Liability
Beware of terms that cap liability for breach of your client's obligations relating to data protection, but (1) allow unlimited liability for losses occasioned by a breach of the broader section covering Compliance with Laws; or (2) allow for uncapped or unlimited liability for "losses that are the subject of indemnification," where some of the indemnifications are for (a) breach of obligations with respect to Personal Data or Compliance with Laws, or (b) breach of representations, warranties and covenants related to compliance with data privacy laws. Also, be mindful that the clause may allow for unlimited liability for breach of a party's obligations of confidentiality, where the term Confidential Information is defined to include Customer Data, of which Personal Data is a subset.
10. Disengagement Assistance
Customers typically want suppliers to provide some level of disengagement assistance at the end of the agreement. Attorneys should consider the following questions:
- Can such disengagement assistance be provided using personnel and resources assigned to the account without adversely impacting performance, and what are the payment terms? Does disengagement assistance include both an extension of the services that were "in-scope" during the term, and "assistance services" for the transfer of specific responsibilities to another supplier (typically knowledge transfer, operational transfer, transfer of resources e.g. intellectual property, equipment, employees)? Does the period allocated for 'assistance services' extend beyond the period allocated for the extension of the 'in-scope' services? Will any service levels be affected as in-scope services are removed?
The answers to these questions should guide attorneys in determining whether such disengagement assistance services warrant additional charges and/or relief from service level requirements.