IT outsourcing disputes: time for a different approach?

IT Outsourcing Disputes: time for a different approach? Introduction It is hardly surprising that issues and disputes commonly arise under large Information Technology (IT) outsourcing contracts. The contracts and the environments they govern are complex, and cover a wide range of technologies, services and projects. They create an extended, close relationship between supplier and customer, who have different motivations and objectives. In challenging times for the industry, it is increasingly important for the parties to large IT outsourcing engagements to ensure that they have a good understanding of the other’s objectives. Where disputes arise, parties should engage with each other in good faith to look for ways in which they may be resolved, to maintain the relationship and, ultimately, the engagement. The case for outsourcing Organisations outsource their IT services functions for different reasons; primarily, a desire to obtain those services at a lower cost. Outsourcing can be used to improve IT and other services within an organisation, sometimes underpinning a broader transformation that is planned or underway. It can give organisations access to specialised capabilities, new technologies and global practices that would be more difficult (and certainly more expensive) for them to obtain independently. There can also be considerable benefits in shifting the burden of IT investment and delivery to an external provider. In return for those benefits, suppliers hope to be able be to deliver their services profitably. Suppliers are unlikely to know with certainty at the outset of the relationship what the costs of delivery will be over the term of the contract. They hope that, by implementing smarter technologies and processes, they can obtain operational efficiencies in delivery of the services. Even so, suppliers’ margins for these services can often be paper thin. Those margins are likely to be squeezed further as the already competitive IT outsourcing market further matures and other options (Infrastructure as a Service, and other cloud-based variants) become more acceptable to more organisations. It is likely that more and more loss-making deals will be signed in the expectation either that things will improve given time, or that other, higher-margin services will be sold to the customer over the life of the engagement. Outsourcing contracting process Following the selection of a preferred outsourcing partner and solution (in many cases, during the selection process), the parties engage in a detailed negotiation of the legal terms which will govern the relationship. The contract negotiation is usually a difficult and prolonged process, for both parties. The proposed engagement is usually intended to be substantial and long term, and includes a large number of variables, obligations and interdependencies that need to be considered and documented. The negotiation often becomes adversarial. The client invariably strives to obtain the best possible commercial and legal terms, knowing that the supplier is likely to be under considerable pressure to achieve its signing targets for the period. Typically, the supplier is much more familiar with the technology and service delivery model than the customer; equally, the customer knows its business and processes much better than the supplier ever will. It is easy in that environment for some mistrust, battle-weariness and even outright cynicism to develop. As a result, when the deal is eventually signed, and the parties are left with a heavily negotiated legal document that they hope will be a reliable framework for the years ahead, the relationship between the parties is likely to have deteriorated to some extent. Outsourcing relationship disputes Against that backdrop, issues and disputes of one sort or another are likely to arise in every large outsourcing engagement. After all, every serious relationship has its ups and downs. Commonly, there will be disagreement as to the scope of the services provided under the contract. Significant scrutiny will be placed on the detail of the technical and financial responsibility documents contained within each Statement of Work, with contract managers and lawyers often hotly debating the meaning of now pivotal words and phrases. In many cases, there are legitimate differences of opinion between the parties, and ones that can carry significant financial implications. Service delivery and the contractual performance targets are often another common area for dispute. Whilst the fault for those issues can of course rest solely with the supplier, the situation will be much more difficult to untangle if the customer or one of its other vendors has done (or failed to do) something that may have contributed to the problem. In many contracts, dissatisfied customers have the ability to take matters into their own hands by withholding payment. In most cases, those mechanisms are used to gain the supplier’s attention or apply pressure in commercial discussions, but they can also be misused by customers, sometimes to devastating effect. Disputes and engagement Left unresolved, minor and major disputes can cause significant damage to the relationship, leading to long-term discord and discontent, on both sides. For the customer, discontent in the vendor management team can seep through to the rest of the organisation over time. It can result in a reluctance to engage the supplier for the kinds of higher margin projects that it may have come to rely upon to wring profit from the deal. Left unchecked, it could also damage the supplier’s prospects of winning an extension or longer term re-appointment at the end of the contract term. For the supplier, disputes can dramatically reduce the profitability of the deal and may even impact the regional and global performance of its business. This is likely to have several unintended repercussions for the customer. The supplier will undoubtedly look for ways to remove cost from its delivery of the services, perhaps at the expense of the quality and reliability of those services. In those cases, what may have started as an initiative led by the customer’s vendor management team to reduce cost can soon impact the everyday user in customer’s business, with negative consequences for all. There is also an important human aspect that is often overlooked. Supplier personnel, especially those critical to the engagement, will often be remunerated according to the underlying financial performance of the account. Strong performers are always in high demand and it may be difficult for a troubled account to hold on to them when it cannot afford to reward them for their hard work. It may also be difficult to persuade replacements of a similar calibre to join the account. Dispute resolution Unfortunately, many IT outsourcing agreements do not cope well with the day to day (or major) disagreements that will occur during the course of the engagement. Typically, dispute resolution mechanisms in an IT outsourcing agreement do little more than require the parties to follow a convoluted series of escalation meetings before litigation (or arbitration) can be started. Structured resolution processes like mediation, which could provide some real benefit, are rarely mandatory in outsourcing contracts and seldom used. Litigation is often (rightly) seen as a ‘nuclear option’ - one that will destroy the relationship. In all but the most extreme cases, for example where termination has already occurred and disengagement has been completed, it may not be an appropriate option. By its nature, IT litigation is distracting and expensive. It requires parties to deal with complex technical and evidential issues in a forum that is likely to be alien to them, turn over many hundreds of thousands of documents to the other side, and tie up important figures in the business for many months or even years. Arbitration may promise a more flexible and confidential process, but is not favoured by many parties and, in any event, arbitral proceedings are likely to have the same negative impact on the relationship as court action. Litigation of matters of this nature will also inevitably bring with it considerable uncertainty. What is certain, however, is that the litigation process itself is unlikely to be a quick or easy one. Stomach for the fight The BSKYB and Sky Subscribers Services Ltd v HP Enterprise Services UK Ltd (formerly Electronic Data Systems Limited) and Electronic Data Systems LLC (formerly Electronic Data Systems Corporation) [2010] EWHC 86 (TCC) proceedings in the Technology and Construction Court in London is perhaps the highest profile case to have come before the UK or Australian courts in recent years. In the BSKYB case, proceedings were commenced in August 2004, the trial started in October 2007 and did not conclude until July 2008. Judgment was not handed down until January 2010. Total legal costs for both parties have been reported to be in the region of $80m. Few organisations will have the stomach for that kind of fight, even if they are prepared to end the relationship with their IT supplier in dramatic fashion. Whilst litigation may not be a viable option in many cases, there is often little thought given as to what other dispute resolution options may assist the parties to resolve disagreements in a structured, amiable and efficient way. Some observers have explained this as a reluctance by the parties to provide an easy route to pursue potentially expensive or disruptive claims. The theory goes that, if the ‘nuclear option’ of litigation is all there is, then the parties are less likely to go to war. Instead, efforts can be made to resolve the dispute in other ways, perhaps by the customer taking other services and products from the supplier at a discount. In that scenario, everyone is happy. While this approach may have worked historically, it has only papered over the cracks in many cases. It may well have encouraged aggressive or dominant parties to push for outcomes that they would not have achieved had the dispute been dealt with in a more structured way. In any event, the ability for parties to negotiate resolutions in this way appears to have receded significantly in the current economic climate. There are fewer viable options in this market to ‘sell to solve’ issues that may arise under large outsourcing engagements, and seemingly a diminishing ability for the parties to trade their way out of their problems. Resolution Options In light of those challenges, it is advisable for suppliers and customers to give more thought to an appropriate dispute resolution structure to deal with issues that arise under IT outsourcing contracts. Experience shows that those parties that undertake thorough preparation when issues arise will be in a far better place to achieve a favourable resolution of them. Time and again, parties that start on the back foot find it difficult to recover, forced to take defensive positions that are unlikely to assist when a dispute escalates. Parties should identify and begin to build a capable team to manage a dispute as soon as it has been raised. That team should include internal and/or external legal advisers from the outset, who can provide the necessary legal and strategic guidance and advice, and drive the matter towards an outcome. In all likelihood, the other party will already have involved its lawyers, whether or not it openly admits to having done so. Once the core team is in place, parties should conduct a detailed assessment of the issues raised in the dispute. There is no better foundation for the successful resolution of a technical dispute than a thorough, accurate and objective legal assessment of the issues and how they might be resolved. Trying to do this on the fly during the negotiation, or adopting a reactive approach to the other party’s arguments will, inevitably, make it significantly harder to achieve an outcome that one is happy with. Only when the team is in place and has conducted a detailed assessment of the issues should discussions as to a suitable framework for the resolution of the dispute take place. Parties should avoid the temptation to keep things casual or ad-hoc, unless the objective is to prolong the discussions for as long as possible (rarely a good idea in the long term). When those discussions do take place, thought should be given as to what dispute resolution mechanism might assist the parties to work through their issues more successfully. Parties should cast from their mind any pre-conceived prejudices that they might have against these methods – they can be combined and tailored to meet any situation, and experience strongly suggests that disputes are more likely to be amicably resolved when those methods are employed. • Mediation: is a non-binding and consensual process in which a neutral third party (often a senior lawyer or retired judge) assists the parties to resolve the dispute. It is generally more structured than commercial negotiation and the discussions and process is facilitated by the mediator. Mediation can be well suited to the resolution of larger disputes in ongoing IT outsourcing engagements, because: • the parties can choose a mediator appropriate to the circumstances, typically a senior barrister who has experience of dealing with complex factual and technical matters • the parties can tailor the mediation and the length of time required for each aspect of it to suit the dispute and their own agendas • the mediator will help the parties to reach a resolution, but he or she will have no authority to impose a solution on them (and generally will not have an advisory role)Nervous suppliers may be comforted that they are not being drawn into a binding process over which they have no control and which could further erode their margins • the mediator can explore sensitive issues in absolute confidence with each party, and only share information with the other party if expressly instructed to do so. This allows the mediator to understand the parties’ positions much better and help them to broker a solution that is acceptable to both • mediation can narrow the issues in dispute. This is particularly valuable for larger IT outsourcing disputes, which can be made up of a large number of issues and questions. Mediation is quick and cost effective and should be considered as soon as possible after a dispute has arisen. Even where the mediation does not result in the resolution of the dispute, in many cases the parties are able to reach agreement shortly after mediation on the basis of the progress made during the process. • Expert appraisal: is a process by which the parties appoint an independent expert to investigate the issues in dispute and provide a non-binding opinion. The independent expert may have a broad investigatory role and can often liaise flexibly with the parties. The expert may give a written opinion which the parties use in their negotiations, or could play a more proactive role in the process, for example acting as the mediator in a subsequent negotiation between the parties. There has been some reluctance amongst suppliers to agree to take part in any process that involves an expert in this way. In large part, this is because it is often (wrongly) assumed that the expert will be a technical IT expert, with well-established views on the issues or parties. In fact, the expert in the process is more likely to be an independent senior lawyer. The issues upon which the expert’s views are being sought are typically legal (not technical) ones, or ones that ultimately turn on some legal interpretation or issue, and so it is appropriate to involve someone who is able to provide meaningful guidance on those matters. • Expert determination: is similar to expert appraisal, but the expert typically makes a binding determination of one or more issues in dispute. It may be appropriate where the parties are keen to have particular issues decided in a fast and efficient manner, but of course the expert’s decision is likely to be in favour of one party or the other. Given that the expert’s decision is effectively unappealable, and is unlikely to take account of ‘softer’ commercial issues (such as the effect that a particular determination may have on the relationship or the long term profitability of the deal), the parties may be reluctant to adopt it. It is also possible to combine one or more alternative processes within a single process. This could occur in a fluid or staged way. For example, expert appraisal or determination could be incorporated for certain issues as part of a wider mediation process. Sydney Angel Place, 123 Pitt Street, Sydney New South Wales 2000 Australia T 61 2 9291 6100 | F 61 2 9221 0872 Canberra 40 Macquarie Street Barton Canberra 2600 Australia T 61 2 6120 4800 | F 61 2 6230 1479 Melbourne 140 William Street Melbourne Victoria 3000 Australia T 61 3 9258 3555 | F 61 3 9258 3666 Email [email protected] www.maddocks.com.au Contact Dominic Keegan | Special Counsel Tel 61 3 9258 3567 [email protected] Conclusion In practice, IT outsourcing engagements only work well where the primary objectives of both the supplier and the customer are met. If the deal becomes unprofitable or unappealing for either party, it is likely to be unsuccessful for both. In challenging times for the industry, when these kinds of deals are the subject of increased scrutiny, it is all the more important for the parties to work together to find a sensible, commercial structure to resolve disputes as and when they arise. Tips for resolving an IT outsourcing dispute • Form the right core team: having the right mix of commercial, technical and legal people involved in understanding the issues and shaping the resolution is vital. Ensure that those people have the capacity to be fully engaged with the team and the process to completion. • Form a robust internal view: document the team’s view of the dispute and resolution options early. Obtain internal support for the recommended resolution strategy and ensure that the core team has authority to settle the dispute at the relevant time. • Protect sensitive communications: ensure that all communications relating to the merits of the dispute and its resolution are protected by legal privilege, in case litigation ensues. • Structure the process: meet with the other party’s core team at the outset of the dispute and agree an appropriate structure for discussions. The agreed structure should be clearly documented, so that it can be used as an effective roadmap for the process. • Identify and narrow the issues: meet with the other party to agree which issues are going to be dealt with in the process. If some issues are more straightforward than others, then consider removing them from the main discussions to streamline the process. • Tailor the approach: in disputes involving a wide range of issues, it may be appropriate to deal with their resolution in different ways. For example, technical issues could be referred to the parties’ relevant SMEs for a joint recommendation to the wider group. • Select a strong mediator: in most cases, mediation will offer an invaluable framework for the broader discussions. Ensure that an experienced and respected mediator, acceptable to both parties, is selected early. Meet with them to discuss the process and timetable. • Consider the impact: the financial and operational impact of any outcome will be key to ensuring an ongoing healthy relationship. Both parties should be encouraged to brief the mediator in strict confidence as to their underlying commercial objectives or constraints. • Document the outcome: when an agreement has been reached, it should be documented and any consequential contract changes effected. Where numerous issues are being discussed, establish a process to document their resolution in a non-binding way.