The due diligence review of existing third-party contracts is a critical component of any outsourcing deal. For the company that is outsourcing part of its business functions to a third party, reviewing existing third-party contracts for certain key terms is an important part of the outsourcing process. Organization, attention to detail, and diligence are keys to a successful third-party contract review process.
The terms that need to be reviewed will be based on the scope of the outsourcing agreement, e.g., will contracts be assigned, terminated, or made available for the outsourcing provider to use. Once the deal constructs are established, Excel can be a useful tool to guide the review of the third-party contracts, by allowing the reviewer to insert the applicable language from each contract into the appropriate row or column. The Excel chart will become a reference guide for the key provisions and provide an overview and comparison between the third-party contracts.
Typical terms to focus on when reviewing the third-party contracts are:
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Contract Expiration Date/Auto Renewal Provisions – It is important to know when each contract will expire and if there is an automatic renewal provision. The length of the remaining term for a contract may determine whether it is transferred to the service provider or retained by the company.
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Third-Party Use Rights and Restrictions – Whether the contract allows for third-party use will be important to determine, and will inform whether specific consents are required. If third-party use is allowed under an existing contract, it can simplify the process whereby the new service provider operates under the contract for the benefit of the company. Other restrictions on use, such as geographical restrictions on where the services or software under the third-party contract can be used, should also be flagged in the review process.
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Assignment Provision – The ability to assign agreements to the service provider is often considered if the company wants to exit agreements and remove itself from the contractual relationship.
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Pre-Paid Expenses/Annual Fees – The amount of resources that a company has already pre-paid for in a third-party contract can often determine how the company chooses to handle the contract. If a contract was signed for a five-year term and the maintenance and support fees for the entire length of the term were due in year one, then the company may be less likely to terminate the contract and absorb the sunk cost if there are several years remaining on the term.
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Termination Rights/Fees – If the company wants to terminate the contract because the services will no longer be needed, it is important to know what termination rights are granted under the contract (including the right of termination for convenience). Often times, a period of notice is specified as being required before termination. The amount of termination fees that would be owed upon termination (i.e., early termination fees for terminating the contract before it expires), should also be assessed when determining whether to terminate a contract.