27 Sep 5 major issues on termination clauses of an outsourcing agreement
Termination clauses in an outsourcing agreements are critical in order to proper manage the migration to a new supplier and pending liabilities.
Regulating the termination of an outsourcing agreement is always one of the first issues that I have in my agenda during the negotiation of an outsourcing agreement. Finding a detailed solution on how to get rid of the agreement when there is a good relationship between the parties avoids issues later on when frictions have emerged and mere good faith principles are too vague to be enforced.
This post is not meant to cover all the relevant termination scenarios, but those that trigger the top 5 issues to rememeber in negotiating termination clauses in an outsourcing agreement.
1. You cannot always have a termination for breach of an outsourcing agreement
A common practice in English law contracts is a “catch-all clause” providing a right to terminate for any contractual breach, followed by a very detailed list of events that entitle either party to terminate.
However, a peculiarity of common law countries,including Italy, is that a termination clause entitling a party to terminate outsourcing agreements
- either in case of breach of any provision of the agreement,
- or on the occurrence of some events that include all the clauses of outsourcing agreements setting out obligations on the other party
could be challenged. Italian case law requires that outsourcing agreements expressly list the events/breaches triggering the termination and therefore their selection might be challenging.
2. Statutory provisions might provide for a “catch-all” termination clause
The solution to the issue mentioned above is given by statutory laws themselves. Indeed, the Italian civil code provides a statutory right under which a party can terminate the agreement in case of occurrence of a “substantial breach” by the counterparty, regardless of whether such breach is regulated/listed in the outsourcing agreement.
And for instance, in case of a major breach, a party might
- either request the termination of outsourcing agreements,
- or assign a cure period to the other party to remedy to its breach on whose expiry the contract is terminated even in absence of a specific contractual provision addressing that breach.
The enforcement of such termination might be more complex (unless the other party recognises the breach) as a court shall decide whether the challenged conduct led to a major breach with a consequential assessment on the relevance of the breach. But this type of provisions set a major distinction between civil law and common law contracts.
3. Termination for insolvency might not be enforceable
Another problematic termination clause is connected to the insolvency of the counterparty. Indeed, in some countries including Italy, clauses providing for the termination in case of bankruptcy of the counterparty would be null and void.
So what is the solution? My personal view (to be adjusted to the peculiarities of the contract) is to entitle a party to terminate outsourcing agreements on the occurrence of events that show a financial difficulty of the other party occurring prior to the bankruptcy. The threshold of “difficulty” however shall be sufficiently high to avoid that the termination can be exercised only during the so called “suspicious period“. Indeed, actions taken during the suspicious period might be subject to clawback so vanishing any effort.
4. A migration plan is a must-have
Apart from identifying termination events (that may also include, among others, the termination at will, for the expiry of the contract, for change of control etc.) to be regulated in detail, outsourcing agreements require a very detailed and strict migration plan.
Indeed, after a long contract the services provided by the supplier might have become an essential part of a business of the recipient. And, in absence of a migration plan, the entity receiving the service would risk to
- be obliged to remain linked to the same supplier for a longer period just because their know-how, data and even personnel is controlled by the supplier;
- hold substantial costs and efforts to switch to a different supplier which might exceed the benefits and force the company to remain with the prior supplier; and
- suffer substantial operational damages and potential legal risks for instance in case of personal data that remain with the supplier after the termination of the data processing agreement.
Also, since the migration will occur at a point when the relationship between the parties might have been impaired, it is crucial that the supplier is contractually bound with a quite detailed exit plan to perform any activity necessary for the proper handing over to the new supplier. For this purpose, it might be wise also to agree a migration period enough long to make sure that it can be performed without causing major operational issues and to define how costs shall be allocated during the migration period.
5. Things change with the digital age
The additional complication in an outsourcing agreement which relies for instance on Internet of Things or artificial intelligence technologies is that the technology from the supplier might have learnt and retain information that enables a level of service which no other supplier might reach. This opens up the major issue around
- the ownership of this information;
- how and in which measure such information shall be transferred to the new supplier, with the additional complication that the initial supplier might argue that the way the information is processed represents its own trade secret; and
- whether the initial supplier can retain that information to improve its own services.
The solution might imply an overlapping between the services of the new and the old supplier which would require also to set detailed rules in the new agreement as to how the onboarding process shall occur and which entity shall bear the relevant cost.
The above is only a brief overview of more frequent issues connected to termination clauses, but as usual I would like to understand your view on the above.
Also, you may review my series of blog posts on outsourcing agreements:
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