Outsourcing’s maturation as an industry has created a substantial body of experience in ‘renegotiating’ and ‘restructuring’ outsourcing contracts. Today, these transactions — sometimes referred to as “re-do” — are more the rule than the exception. The frequency with which they occur, in fact, has led to a disturbing tendency to generalize when these experiences are being discussed.
The truth is re-dos don’t fall into a one-size-fits-all category. Not all experiences are positive, and not all are negative. An approach or strategy that may have worked well in one outsourcing re-do may not work at all in another. Both the strategy selection and the outcome of a renegotiation or restructuring experience will depend on many factors, including the motivation for the transaction, the contracting philosophies of the parties, the past experiences of the parties, and the business context in which the renegotiation or restructuring is taking place. The legal strategy and the way in which a party will use its legal team also will vary depending on these factors.
In the Normal Course of Events…
Understanding the different types of renegotiations is important. In any healthy outsourcing relationship, there will be a fairly constant need for ongoing discussions between the parties to ‘fine tune’ the contractual terms of their outsourcing deal. These ordinary course — or ongoing† negotiations should not be confused with a material renegotiation or restructuring of the contract.
A well-documented and known fact today is that one of the key reasons that early outsourcing deals got into trouble was the failure to recognize, plan and contract for the constantly changing IT environments that were being placed under long-term contracts. Under even the best contractual structure, there will be a need to adjust terms related to service scope, pricing and service level agreements in response to normal business variations. The parties should anticipate this going into a deal and be prepared to deal with each other in a flexible manner. The transactions discussed in this article are the more material or fundamental renegotiations or restructurings of the outsourcing contract and relationship. Such transactions will be less frequent and will usually involve the type of work, meetings and negotiation sessions that transpired during the original negotiations.
Renegotiation vs. Restructure
Although the terms often are used interchangeably, the meanings of these two words are different. A ‘renegotiation’ generally is thought of as an agreement by the parties to modify one or a limited number of particular elements of an outsourcing contract. For example, several years into a contract, an outsourcing customer may believe that the outsourcer’s pricing should be lower due to reduced technology costs available in the marketplace. The customer may, in that case, initiate a ‘renegotiation’ of the contract pricing.
Contrast that with a situation in which both parties have come to the conclusion that the contract fundamentally does not describe the relationship the parties want to have. Rather than modifying certain existing terms of the current contract, this scenario may call for a re-thinking of the structure of a number of key contract provisions. For example, an outsourcing customer may decide to move the outsourcing relationship from purely a customer-vendor or ‘commodity’ arrangement to a more strategic relationship. While much of the original contract may remain intact in this scenario, there will be significant revisions to many of the key business terms in the contract.
When the Gloves Come Off…
No matter what circumstances drive a party to classic renegotiation or the restructure, the re-do process, if approached correctly, can be one that is positive and strengthens the relationship tie between the parties. That situation changes fundamentally, however, if the parties are under a strictly commercial or commodity-driven contract and a strong commercial relationship is not a goal of the parties. Then the re-do can be approached in the good old-fashioned way of hard ball negotiating. Each side can attempt to exercise its perceived leverage against the other, engage in some adversarial negotiations and let the chips fall where they may. There are plenty of resources available today for those who want to learn the most effective tactics and ploys of this approach.
In the more sophisticated and strategic outsourcing deals today, this generally is not the basis for the parties’ commercial dealings, but circumstances can arise to force renegotiation in a negative manner. There have been outsourcing deals done in which both the customer and the outsourcer began with ample mutual best interests in mind. However, a year or more into the deal, a mistake is discovered in one of the key economic or business assumptions on which both parties relied in structuring the original service scope and pricing. Or a particular contractual provision in the original contract was written hastily and in an ambiguous manner at the end of a long night of negotiating, because the parties were in a hurry to sign the contract. These types of ‘contract problems’ occur frequently. The rub is that any ‘fix` will mean that one party to this ‘partnership’ will suffer a significant financial hit.
This is where the relationship will truly be tested. The party that stands to suffer the hit may, of course, be reluctant to do so. At this stage, the focus often is on preserving or asserting legal positions based on contract interpretation and legal theories. When this begins, it is difficult to establish open business discussions that could lead to a resolution. If both sides stick to such an approach, the deal will almost certainly terminate, perhaps with a great deal of animosity and high legal fees. That is why outsourcing attorneys who understand the business context of outsourcing will recommend that the parties include mediation and binding arbitration procedures in their outsourcing contracts. In particular, the mediation process can sometimes facilitate a business resolution to a dispute that otherwise would poison the relationship.
The Ultimatum Mentality
Not all ‘negative renegotiations’ will arise in the context of a contract dispute. Often the renegotiation starts out negatively because that is the approach adopted by the party desiring the modification of contract terms. For example, the customer wants lower pricing (but refuses to acknowledge service level impact) and threatens to exercise its termination for convenience clause unless the outsourcer lowers the price. Or the outsourcer finds that its profit margins are too skinny to allow it to staff properly to meet its contractual service level requirements, and it notifies the customer that its prices must be raised or the outsourcer will continue to let its performance degrade.
These take-it-or-leave-it scenarios do not bode well for long-term, mutually beneficial relationships. Nevertheless, there are some companies that can’t seem to approach business any other way. If this is inbred in the culture of the company’s organization, then it should be recognized for what it is by those who choose to do business with that organization. Unfortunately, this approach and culture will not foster future success stories in outsourcing.
Obviously, for a renegotiation to be successful, it must be approached with a ‘win-win’ philosophy in which both sides will benefit over the long term.
The Positive Side to Re-Dos
Fortunately, many re-dos have been positive experiences for the parties involved. They should be. Both the customer and the outsourcer should have gained a great deal of knowledge about each other and their mutual expectations for the relationship. They now will have actual experience in dealing with each other and the outsourced service environment. There should exist a basis for a higher degree of trust in the relationship. Much of the time, effort and focus required in the original contract negotiations can now be more limited and focused only on the parts of the contract and the relationship that require change. And if the basis of the re-do is satisfactory, more than likely the term of the contract will be extended — a benefit for both parties.
It is important that in initiating the re-do both parties set aside the particulars of the contractual issues and focus on the business basis and objectives for the transaction. This is the opportune time for the parties to explore creative ways to structure their relationship and to ensure that their objectives match. While the parties’ attorneys in a ‘negative re-do’ situation may act as adversaries, the parties in a positive re-do situation need outsourcing legal counsel who understand the business context of the deal and who are creative relationship builders. Such legal counsel can be invaluable in helping to ensure that the parties’ interests are aligned and, at the appropriate time, ensuring that the intent of the parties is accurately and adequately expressed in the revised contract.
Since much of the focus of a re-do may be to fix some problem areas of the relationship, the negotiating teams must be very careful to keep the discussions positive. Negotiators can be firm, but fair. Everything possible should be done to keep personalities, emotions and politics out of the discussions. With the significant investment that both parties have in the outsourcing relationship, a re-do of the contract should be a time to revitalize the relationship, not to sow seeds for future discontent.
Bill Deckelman is a shareholder with Munsch Hardt Kopf Harr & Dinan, P.C., a lawfirm specializing in outsourcing, with offices in Dallas and Austin, Texas.
Lessons from the Outsourcing Primer:
- Every re-do is different, depending on the motivation, philosophies and experiences of the parties, as well as the business context of the event.
- Understanding the differences between ‘fine tuning’ contracts and material re-dos is essential.
- The re-do process, if approached properly, can strengthen the relationship.
- Although circumstances can dictate adversarial negotiations in some situations, the more generally accepted practice is to focus on the positive.