Outsource deals end in divorce

The recent honeymoon that firms across multiple sectors have been enjoying
with outsourced service providers is drawing to a close with a “significant
number” of outsourcing agreements now ending in divorce, legal experts have
warned.

According to law firm Lawrence Graham, a breakdown in the relationship
between the providers and recipients of outsourced services can lead to
expensive and protracted legal battles as companies try to extricate themselves
from complex service agreements.

Lawrence Graham solicitor Clare Mackay, author of a newly published briefing,
Disputes in outsourcing contracts – when two worlds drift apart, advises that
firms looking to ditch unsatisfactory outsourcers must think through the
commercial consequences of termination very carefully before considering legal
action.

First steps

The first questions that firms seeking to terminate an outsourcing agreement
must ask themselves include:

• Can you extricate yourself from the contract without doing even more
damage?
• Is it possible to take a step back?
• Do you really want to terminate?
• Is this the best solution?
• What if it leaves you with a gaping hole in your services?
• Could you plug that hole by taking functions back in house or making
arrangements with another supplier?

Terminate with extreme caution

According to Mackay, a company that has reached the decision that termination
is the best way forward should begin by retrieving its original agreement and
examining the termination clause.

Typical contracts will include one of the following get-out clauses:

• A clause permitting termination when the other side is in breach of its
obligations. Often, termination is only permitted where the breach is ‘material’
and has not been remedied within a certain period of time.

• A clause permitting termination for any breach, no matter how trivial.
However, this kind is likely to be unenforceable unless it is very clearly
worded.

• A clause entitling either party to terminate purely for reasons of
convenience and by serving a set period of notice. Care should be taken to
ensure that the correct notice period is given and that the notice is sent to
the correct address by one of the methods specified in the clause. Also watch
out for supplementary clauses which might now kick-in, perhaps obliging payment
of a severance payment.

Another common exit clause will permit termination “in other specified
circumstances”. These might include insolvency or a change of management at the
outsourcing provider.

Other escape routes

Contractual termination clauses are not necessarily the only potential escape
routes. Other possible legal exits can come from the following circumstances:

• Is the term that has been breached ‘vital’? In other words, does it
substantially cause deprivation of the very benefit that the contract was
supposed to deliver? If so, the outsourcing provider is in what is known as
‘repudiatory breach’, giving its customer the right to terminate immediately and
to claim damages.

• Even though the time may not yet have arrived for the other party to
perform some important obligation or other, if it has already made it clear that
it will not do so when that time comes (or if it has done something which now
makes it impossible for it to do so), then this too is a repudiatory breach,
this time by the other party.

• If what a company is told before the contract was signed varies wildly from
what has actually been delivered, and if this unfulfilled promise was a deciding
factor in adopting the agreement, then it may be possible to ‘rescind’ the
agreement on the basis of misrepresentations.

Costly failed termination

The decision to terminate a contract should never be taken lightly, Mackay
stresses. Firms should only take this course of action if they are confident
that they really do have grounds and that they can prove them. Failure to do
this could leave the firm attempting to kill the contract in repudiatory breach,
which may give the other side grounds to terminate and claim for damages.

What’s the damage?

Even if a firm decides not to terminate, it may still have a claim for
damages for breach of contract. Such damages are assessed in order to restore
the injured party to the position that it would have occupied had the contract
been performed in full accordance with its terms.

Recoverable losses are defined as those which ordinarily arise from a
contract breach of the type in question – loss of profits or, alternatively, the
expenses incurred (or losses suffered) as a result of entering into the
contract.

Liquidated damages clauses

Firms should also check their contracts for a ‘liquidated damages clause’,
which provides at the outset for a defined sum of money to be paid in the event
of a breach. A clause of this kind is enforceable provided it is a genuine
pre-estimate of the kind of loss that might arise from a breach of the contract.

Damage limitation

Many agreements contain clauses which seek to exclude or limit the amount of
damages recoverable for breach of contract. However, Mackay notes that the
courts are reluctant to interfere in the terms of commercial contracts that have
been negotiated individually.

Exclusion or liability limitation clauses generally seek to:

• Cap the amount of liability that one party has towards another;
• Restrict the heads of loss that a party can recover – usually by reference to
vague terms such as ‘indirect’ loss.
All these factors considered, Mackay warns that contract termination can be a
minefield in which ill-judged action can easily make matters worse in both
commercial and legal terms.

Firms must think through grounds for termination and the practical
consequences of so doing well before biting the bullet.