EXIT OR BUST

SSON News and Analysis
Posted: 07/09/2012


For some, this change in market conditions is not something that was anticipated, and is therefore not provided for in the agreement. Where that is the case—on what basis can a party exit an agreement that they have entered into?

WHY A DEAL MIGHT NOT WORK IN THE CURRENT CLIMATE
As a lawyer in private practice dealing mainly with outsourcing agreements and shared services projects, I have, over the last few months, found an increasing number of clients seeking to exit or substantially alter their existing agreements. Typical reasons for this have included:

  1. The deal involves service charges that are payable in a currency other than pound sterling. The steady drop in the value of the UK pound against other currencies has meant for some UK customers that the service has become much more expensive than at the time the deal was struck;
  2. The deal assumed a steady growth in demand (based on historic figures) and built in to its pricing an assumed requirement for additional resource, additional data centers or additional assets, which is now not required;
  3. The solvency of either the provider or a key sub-contractor is now in doubt, making the customer nervous about future support; or
  4. The drying up of credit or tighter controls on credit means that the customer’s own cash flow is under threat, making him nervous as to whether it can still afford the service.

WHERE DOES A CUSTOMER STAND WHEN HE NEEDS TO EXIT OR VARY AN OUTSOURCING CONTRACT?
Of course this largely depends upon the wording of the contract that is being terminated. Ideally (from a customer perspective) it would include wide termination provisions allowing termination of the contract "for convenience" and provisions allowing the customer to unilaterally change the volume or quality of the services depending upon demand.

WHERE THIS IS NOT THE CASE, HOWEVER, WHAT REMEDIES DOES A CUSTOMER HAVE THEN?
Typically, there are a few areas upon which a customer might seek to rely in order to force through an exit.

These include:
RELYING ON THE "FORCE MAJEURE" CLAUSE
A "Force Majeure" clause typically provides that a party is not liable for a failure to deliver a particular service, where that person is unable to perform for reasons outside his or her reasonable control (and usually provides a termination right where this situation continues for some time). This clause would normally include issues such as fire, flood or outbreak of war and is one that is commonly relied upon by suppliers, but applies to both parties. Can "force majeure" be relied on in order to exit for one of the reasons highlighted above?

The problem is that being unable to perform a contract (particularly where this involves little more than payment of a service charge) is extremely narrowly interpreted. The fact that a service is more expensive, even to the point of threatening to put the customer out of business, is not likely to be enough to amount to a force majeure event.

Equally a "reason outside a party’s reasonable control" is likely to be similarly narrowly interpreted. Taking the above reasons as an example, in reality it is possible to hedge against currency movements or a fall in demand and also to insure against insolvent suppliers—so are these things really outside the customer’s control? The mere fact of insurance being available (and not taken) does not necessarily mean that a customer is unable to rely on Force Majeure but it might make it a more difficult proposition to argue.

"FRUSTRATION"
If there is no "Force Majeure" clause then an argument might be that the contract has been "frustrated" meaning that both parties’ obligations are treated as discharged and both are released from any future obligations under the contract. Typical examples of a customer being able to rely on the doctrine of "frustration" would be where it has hired an asset which was (unknown to the customer) destroyed prior to the contract, or where the contract required a specific individual to perform the contract and that individual has died.

The test for frustration however is even more stringent than for force majeure— understandably, since a court will be even more reluctant to allow a contracting party off scott-free, where the contract provides no such relief. It has to be practically impossible for a party to comply with its obligations, or the contract must have been radically or fundamentally changed by some intervening event in order to rely on the doctrine of
frustration.

A court will expect the parties to take a certain amount of commercial risk and it is likely to be difficult for a customer to rely on frustration to exit a contract that is not impossible to perform (even if the contract does now appear an expensive mistake).

NEGOTIATING A CHANGE
Seeking to terminate for force majeure or on the basis of frustration is unlikely to help your relationship with your provider and, equally significantly may well fail if it reaches court (although it may be worth taking advice based on the wording of the clause, as force majeure clauses can be drafted very differently).

That being the case there may well be a good reason for seeking a change to the contract, whether under the change control process or otherwise. This is likely to involve a compromise with the provider on certain issues in order to agree a swift exit, as change control mechanisms are ultimately dependent upon a bargain being struck. If the supplier is able to agree the suspension or termination of a certain service, it may be that the customer will have to accept more onerous terms, or an extended term in respect of other services that it continues to accept.

HOW TO AVOID IT NEXT TIME
We are likely to see difficult trading conditions for some time yet, with only the most optimistic commentators predicting an upturn in 2009.

Assuming that you’re not currently in a position of having to negotiate an exit there are still some points to consider for your next outsourcing arrangement, or your current contract comes up for renewal, such as:

  1. How solvent is your supplier and/ or its subcontractors? Do they have sufficient insurance in place in the event of their insolvency?
  2. How quickly, if required, could you step in to provide the outsourced services? Do you have up to date records of the services being provided? Do you need these to be stored (and updated) in a central (or virtual) location? Do you have audit rights that would allow you to obtain these before termination?
  3. If third party software or assets would be needed to provide the services, do your exit arrangements allow you to obtain these at short notice?
  4. Do the change control provisions in your agreement allow necessary changes to the contract to be evaluated and agreed quickly?

Whatever [the rest of 2009] might bring one thing that can be relied on is that both the market and your requirements as a business will change. Ensuring that arrangements with suppliers are robust and flexible enough to cope with this change when it happens is likely to make the difference between a painful and costly exit and a smooth transition to a new service.

SSON News and Analysis
Posted: 07/09/2012

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