As a follow-up to our recent post on third-party contract due diligence in outsourcing deals, this post focuses on how customers in outsourcing deals handle the disposition of legacy third-party contracts—one of the thorniest and most work-intensive work streams—once diligence has concluded.
Inventory and Review
As noted in our previous post, a well-organized collection and review process is key to the efficient disposition of third-party contracts. The terms of the underlying contracts inform and often determine the disposition of such contracts.
Potential Disposition Categories
Commonly used disposition categories include the following:
- Assign – The contract is to be assigned to the new service provider. Whether the contract is assignable without consent, and if not, if the third party is likely to consent to the assignment, will be key to the determination of this category.
- Managed/Support Contracts – The new service provider will access or use the underlying assets or services in connection with the services for which it will be responsible. The new service provider will manage the contract or act as the customer’s agent under the contract, but the customer will retain the contract in its name.
- Terminate and Replace – The legacy contract may be terminated and the new service provider will replace the services offered under the terminated contract with its own services or a direct agreement with the existing third party.
- Retire – The assets or services are not required under the outsourcing agreement, and the legacy contract will not be renewed or replaced by the customer.
Factors to Consider When Applying the Dispositions
There are a few key items to focus on when determining the disposition of a contract:
- Prepaid Amounts – Has the customer prepaid or committed to pay certain amounts under the contract? If so, can they be recouped, or transferred to the new service provider?
- Third-Party Consents – Does the third party need to consent to the customer’s intended disposition of the contract?
- Termination Fees – Does the customer need to pay a fee for terminating the contract before the term expires?
The disposition of legacy contracts can have a significant impact on the customer’s and the service provider’s business case. In many cases, an existing third-party contract (and the associated fees) can be terminated and the assets and/or services covered by such contract can be replaced by the service provider (and included in the fees for the services provided by the service provider). In other cases, if the customer needs to retain a third-party contract, the ongoing fees associated with such contract need to be cared for in its overall business case as a “retained cost.”
After the parties have executed the outsourcing agreement, additional third-party contracts may be identified. The parties should prepare for this possibility by agreeing on a procedure for dealing with “new” third-party contracts ahead of time. This enables the parties to handle these contracts in an organized manner with a prior agreed-upon plan, including whether there will be financial implications. This process also can be used if one of the parties believes that a change in the existing disposition of a third-party contract is warranted.