Outsourcing Contracts I Have Known and Loved

In the past few years I have had frequent opportunity to review and negotiate contracts between banks and their chosen outsourcing vendors. Without sacrificing client or vendor confidentialities, it is well known that a contract written by a vendor is weighted in the vendor’s favor. Actually, if it were possible to physically weigh the interests on either side, the bank’s would weigh in at five pounds and the vendor’s would tip the scales at 95.

But with such large expenditures at stake, why oh why are so many banks signing these contracts with nothing more than a cursory glance? Let’s look at the numbers. A typical mid-sized bank can expect to pay between 15 and 20 basis points on average assets per year. For a $3 billion bank, that is between $4.5 and $6 million per year. Accounting for growth and cost of living increases, this totals at least $30 million over five years!

It is not my intent to cast aspersion onto vendors. If I were a vendor writing a contract, I would want to protect my interests at all cost. Let me share a few examples of how they do just that. These are real life clauses I have seen in vendor-provided contracts.

• [Vendor] is not responsible for the software performing correctly.
• The software has known defects and [vendor] is not responsible for said defects.
• In the event of an early termination, [bank] is liable for the remaining payments plus a penalty of 50% of the remaining payments. (A termination cost of 150% of the remaining payments.)
• Should the system fail, a backup will be available within two weeks.
• Prices may be increased at any time with 30 days notice.
• [Vendor] will make a reasonable effort to meet with the financial institution each quarter. (A conflict with a golf outing might be reason enough NOT to meet with the bank.)
• In the event of a default by [bank], [vendor] will immediately cease providing services. (I’ve always wondered how the regulators would respond to someone shutting down a financial institution.)
• Fees passed through to [bank] will have a 25% administrative fee added to them.
• [Vendor] will adjust prices annually based on its internal costs. (Hmmm, I wonder… what is the incentive for efficient performance?)
• [Bank] is totally responsible for meeting state and federal regulations. (I’m not sure what the vendor is being paid for.)
• Any service not specifically stated in the contract will be charged the current price as stated in the price book. (The vendor was unwilling to provide the bank a copy of the price book!)

From the vendor’s perspective, there is a rational reason for every one of these clauses. However, the clauses were generally created as the result of a bad experience and do not fairly represent the relationship between most banks and their outsourcing vendors. In the negotiations in which I have participated, the vendor has always been willing to make reasonable changes to balance contract terms. All you have to do is ask.

You may think I am encouraging banks to recruit their legal beagles to create new contracts. This is not the case, since such an effort would only result in the same terms with different words. Keep in mind vendors have certain protections they must obtain.

Here are a few steps a bank can take to help create a balanced document that protects both parties’ interests.

1. Provide your new vendor with a list of contract requirements. This is high level and usually includes term of contract, conversion date, etc. These items should be the deal killers. They are not negotiable. They are often included in a Request for Proposal (RFP).
2. Have a knowledgeable person review the first contract draft. This individual must be familiar with the business issues contained in a bank outsourcing agreement. It could be someone in the bank, your counsel or a third party.
3. Document all verbal promises made during the sales/renewal cycle.
4. Ensure the list of verbal promises is included in a list of business issues identified in the contract review. (Service levels is an example of an important business issue.) Number and clearly define the items, and include specific contract section references and space for comments. Send this list to the vendor and request a response. The agreement should have very specific performance measures, with consequences if they are not met, including breach if serious enough. Most boilerplate contracts do not address performance levels. Without them, your only recourse with poor performance is an attempt to prove breach. Keep in mind this is not the time to get involved in the legal issues; they will be dealt with later.
5. When a response is received, it is easy to look at what your vendor is willing to do. Make comments on the document, add new ones and return it to the vendor. Keep repeating steps 4 and 5 until you are satisfied with the responses.
6. Once you’ve reached agreement on the issues, ask for a revised contract incorporating the agreed-upon issues. Review this version of the contract to validate the suggested wording. Iterate this process until all of the identified items have been resolved.
7. Now that the business issues are resolved, get your counsel involved (internal and/or external) to make sure the contract meets the bank’s legal needs. At this point, it is best to have your counsel and the vendor’s counsel work together. They will ensure a sufficient number of “whereases” and “wherefores” have been included.
8. Put the contract in the file and know that if you ever have to look at it you’ve taken steps to protect your interests.

Fortunately, this process only needs to be done once every four or five years. Make sure your next contract balances the scales.
-cf