FEBRUARY/MARCH 2004
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IT OUTSOURCING - CAVEAT EMPTOR!
What is involved and what to look for
by James Keller
Schwartz, Manes & Ruby
A popular business cost savings strategy today is that of "outsourcing". This concept is gaining much attention via the political arena and likely to be a major issue in the upcoming Presidential election, i.e., outsourcing of U.S. jobs to other countries. Keeping with this trend, information technology (IT) outsourcing is becoming more popular such that many of you working in the areas of business, consulting, accountancy and law may encounter an outsourcing proposal involving your clients or your own IT function. This article is intended to provide some food for thought when evaluating an IT outsourcing agreement.
1. Are software licenses still necessary for the "outsourcer"?
This may surprise you but the answer is likely to be "maybe". That is because software licenses are personal as to a user. Large IT outsource vendors such as EDS, IBM, HP, etc., certainly have software licenses in place with a number of software vendors, however, these licenses generally limit use to that specific user and not their clients. Some firms do purchase multi-user licenses but rarely do so due to the cost.
Not to worry. Most software firms are receptive to modifying your software licenses to permit use by a third-party vendor on your behalf, however, there is a transaction cost for doing so and the cost may be very close to your annual license fees. Therefore, do not immediately count elimination of software license fees to be a benefit of outsourcing until you have done your homework.
2. Long-Term Contracts vs. Short-Term Contracts.
While many would argue the synergies associated with the familiarity and knowledge base developed by the vendor of the vendee's systems would translate into favoring long-term over short-term agreements, there are nevertheless more practical reasons for choosing the shorter term alternatives. That primarily being flexibility. The flexibility provided by a short-term contract can serve to better manage the risks experienced in the ever changing arenas our clients are competing in. Simply put, predicting business needs beyond a couple of years is really difficult for most firms, given the dynamic nature of IT needs. The risks associated with locking into the wrong arrangement for a period of yours in simply too compelling. Therefore, the trend here is one of "shorter is better".
3. Contract Provisions - Less is More.
While in most business contracts, the more specific the details, the better applies, that is not necessarily the case with IT outsourcing. By this, we mean that specifying every task that should be performed by the vendor in detail may result in a lack of flexibility. That said, the services to be provided and related time frame in which the services are to be rendered certainly must certainly be pounded out. Therefore, in putting your agreement together, keep the big picture in focus and avoid getting tied up in overly specific and what may prove to be overly rigid and, perhaps, "dead locking" details as to vendor tasks under the contract.
4. Termination Clauses
As in most relationships, an exit strategy should be negotiated at inception of the deal. However, many times vendees overlook the practical aspect of exercising a termination clause. How so? Even though you are dissatisfied with the current vendor and you have astutely negotiated contractual language allowing you to "fire" the vendor after providing up to three (3) months notice, this may nevertheless be an illusory option. That is due to the difficulty you may encounter in trying to find a replacement IT provider. Finding an adequate replacement within the necessary timeframe is not always an easy task for a number of reasons so, don't overestimate the ability to fire your current vendor.
A further caveat in this area involves the potential bankruptcy of a vendor. Can I terminate my IT outsourcing contract upon notice of vendor's Chapter 11 or Chapter 7 filing and switch to a new provider? No! You need to do this before the vendor files bankruptcy. This is because bankruptcy laws generally bar unilateral terminations of continuing contracts by the nondebtor. When a contractor files for bankruptcy under either Chapter 7 (liquidation) or Chapter 11 (reorganization), the "automatic stay" provisions of the Bankruptcy Code take effect. This means that irrespective of what your contract may say to the contrary, you will not be permitted to terminate a contract with a vendor who has sought the protection of the bankruptcy courts, usually for the duration of the bankruptcy case. Therefore, you could be locked into your agreement for a long time.
Under the U.S. bankruptcy laws, a Chapter 11 debtor has three choices with respect to the remainder of your contract: It can assume the contract; assume the contract and assign it to another provider; or it can reject the contract. While there are some limitations on the debtor's exercise of these rights, the key points to remember are that (1) all three of these choices are available and (2) that under the Bankruptcy Code, the debtor is given until confirmation of a plan of reorganization to decide which option to select. The only effective limitation on the period of uncertainty caused by a provider's bankruptcy is the expiration of the contract by its own terms.
While we certainly have not exhausted the topic of negotiating IT outsourcing agreements, we hope this has provided some brief but meaningful insight for your plan of attack in evaluating IT outsourcing agreements in the future.
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