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Tech & Sourcing @ Morgan Lewis

TECHNOLOGY, OUTSOURCING, AND COMMERCIAL TRANSACTIONS
NEWS FOR LAWYERS AND SOURCING PROFESSIONALS

Nearly every form of service agreement contains a provision restricting the ability of one or both parties to subcontract their obligations. A typical provision (with a standard quick and dirty markup) might look like this:

“Vendor shall not subcontract any of its obligations under this Agreement without the express prior written consent of Customer, which such consent shall not be unreasonably withheld. The subcontractors set forth on Schedule X are hereby approved by Customer.

These limitations are often included as a standard part of the legal boilerplate without much thought, but can present significant problems, especially given the broad use and incorporation of third-party technologies and services.

Consider, for example, a typical software as a service platform vendor. It is likely that the platform vendor uses (1) a hosting provider to serve its application; (2) a call center to assist with customer service; (3) security and penetration testing firms; (4) independent contractor software developers; (5) a marketing and graphics design firm; (6) fraud prevention vendors; and (7) payment processors, just to name several “subcontracted” aspects of a typical platform.

Sometimes, the party asked to make the promise just ignores the restriction and carries on, hoping that there is never an issue. Or, perhaps, the party will list a few of its major subcontractors that it feels are important enough to list, ignoring more mundane subcontractors. Rarer still, the party might drop in a very expansive list of every contractor it uses, so as to avoid a foot fault. Almost never is the list updated in any meaningful way after execution, and almost never is there any real thought from the counter-party doing any diligence on the subcontractor list.

In today’s environment, overbroad subcontracting restrictions seem to be more of a headache than something that offers any real protection. One solution is to be more thoughtful about the restriction, and craft it in a way that is both limited enough that it doesn’t pick up contractors that are truly ancillary to the transaction, yet is still broad enough to mitigate risks that are actually appropriate to the transaction.

If your organization is routinely arguing about the disclosures to make in a subcontracting provision, consider a “Material Subcontractor” style provision that provides some thought into the types of approval rights that make sense. Here is an example of how such a provision would look:

Vendor may not subcontract, without the prior written consent of Customer, to a third party any of the following activities (a “Material Subcontractor”):

a. the provision of a significant portion of the Services;

b. any use, hosting, or having more than incidental access to, any Customer Data;

c. any portion of the Services subject to a regulatory framework; or

d. the development of any intellectual property.

These categories are not intended to be exhaustive, and different organizations may care more about certain types of subcontractors than others, but the notion that a subcontractor restriction might be narrowed to become more meaningful and reasonable could be helpful if you are having problems in negotiations.