08 Nov 2012

Have you planned your exit? Exit management of an outsourcing agreement

by Alexandra Wedutenko, Lucinda Watson

Going into an outsourcing agreement without setting out your exit strategy could be a very expensive mistake.

Although it may not be obvious to focus on the end before entering into an outsourcing agreement with a supplier, this is the best time to be planning for the eventual termination or expiry of the agreement, as everyone wants to finalise the deal and establish good working relationships.

Once the agreement has ended, it will be much more difficult to agree the arrangements for transitioning the outsourced services back to the customer or to another supplier, particularly if the contract is being terminated for the supplier’s breach. Without these arrangements, however, it will be hard for the customer to ensure business continuity or easily re-tender the services.

The UK decision AstraZeneca UK Limited v International Business Machines Corporation [2011] EWHC 306 (TCC) is a useful reminder of the importance of planning for exiting a complex outsourcing arrangement, and clearly detailing the exit management provisions – and why failing to do so can be a costly mistake.

The AstraZeneca and IBM dispute

AstraZeneca and IBM made a Master Services Agreement (MSA) for the provision of IT infrastructure services, which AstraZeneca terminated three years early.

The MSA contained detailed exit management provisions and a schedule setting out the termination assistance to be provided on expiry or termination. IBM was required to continue to provide ‘Shared Services’ using ‘shared infrastructure’ for a further 12 month period after the end of the exit period, if associated systems and third party contracts were not transferable and the successor supplier was unable to provide replacement services. Unfortunately ‘infrastructure’ was not defined or used consistently in the MSA.

IBM said infrastructure did not include data centre facilities. The judge disagreed; references elsewhere in the MSA to 'infrastructure' included building and office space, staff, and security, so 'shared infrastructure' included equipment, systems and facilities at IBM’s shared data centres, power, fire detection, cabling and telecoms, not just IT hardware and software. IBM therefore had to provide services in its shared data centres for up to a further 12 months after the exit period.

Under the MSA, IBM was to be paid a fixed fee for provision of termination assistance, but again a crucial detail was missing – its amount. The judge found this could have been set out and was not conditional upon the exact exit period being defined. Ideally the parties need to set out the exit fee or the basis for calculating the exit fee to avoid a fee dispute.

The judge also ruled that:

  • subject to provision for Shared Services after the end of the exit period, IBM did not have to continue providing its services until all its responsibilities had been assumed by AstraZeneca or another supplier, but could stop after the defined exit period; and
  • AstraZeneca was obliged to provide an IT Transfer Plan, as one was required to enable IBM to perform its obligations, but that this was not a pre-condition of IBM providing termination assistance.

Tips for exit management

Neither party in this case got everything they wanted, and they spent a lot of money in litigation. To avoid their fate, an exit plan should be set out in the contract in as much detail, and with as much clarity, as possible. At a minimum, the contract should set out:

  • the scope and duration of exit management assistance that the supplier will provide, including any services that will be excluded and any obligations of the customer;
  • any fee or the basis of calculation of the fee payable for the exit assistance;
  • any assets and third party contracts that will be required by the customer and that may transfer from the supplier and/or be purchased by the customer (and how to price those assets);
  • which assets and services are shared with other customers of the supplier and what will happen with shared assets;
  • any ability to hire the supplier’s employees who have been providing the services;
  • an obligation on the supplier to provide information relating to the services (knowledge transfer); and
  • an obligation on the parties to review and update the exit plan throughout the term of the contract (for example, annually).

To assist with a smooth transition of services from the supplier, the supplier should be obliged to co-operate with the customer and any other suppliers, and to provide the outsourced services for a period of time after termination.

If the supplier is investing in the outsourcing arrangement (for example, by taking out leases, buying hardware and software) it will usually seek to amortise these costs over the life of the contract. They will typically seek to recover any costs left unrecovered by an early termination of the contract. Rather than find out what this (potentially high) cost of termination is after making the decision to terminate, customers may, depending on the nature of any leases, seek prior transparency of the costs. Any termination fee designed to compensate the supplier for unamortised costs should decrease with each passing year of the contract.

In practice it is unlikely that all rights and obligations in relation to exit management will be finalised at contract signature. It will therefore be important to include in the agreement a minimum set of requirements in as much detail as is possible, and to also set out an obligation on the parties to agree in more detail the exit plan and periodically update that plan.

The customer can also help to further protect itself by ensuring that it retains knowledge internally of the outsourced services (for example, by requiring the supplier to maintain a procedures manual detailing how the services will be performed, maintain an asset register, and provide regular information and reports on the services).

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.