What Outsourcer Satyam's Ownership Change Means to Customers

CIO — As the fallout from the Satyam scandal continues, many outsourcing clients of the beleaguered Indian outsource—as well as customers of other offshore outsourcers—are examining their options.

While each customer's opportunities will depend on its specific contractual rights, many outsourcing agreements include a provision allowing the customer to terminate the agreement without payment of a termination fee (or payment of a reduced fee) upon a change of control of the supplier. However, because the customer bears the cost of re-sourcing the terminated services, termination usually makes sense only in the most extreme cases. Instead, the termination right is most practically viewed as a device for bringing the new owners to the table to negotiate additional protections appropriate in light of the changed circumstances. Those protections will vary, but might include:

• Obtain credit support, such as a guaranty or letter of credit. The customer's request will depend on the post-acquisition structure and the financial condition of the buyer. If Satyam remains intact as a subsidiary of the buyer, a parent company guaranty (assuming a creditworthy parent) would seem to be essential to protect against a future melt-down relating to as-yet-unresolved investor and other claims. If Satyam is merged into another entity, customers will want a full credit analysis of the survivor. In all cases, customers should consider whether third party credit support of some kind will be necessary. Of course, the cost of any credit support required will burden the deal and may challenge the economics for both sides.



• Sign financial covenants which, if triggered, result in a requirement to provide credit support, a full or partial termination right or both. Typical high-yield debt covenants are a good place to start in structuring these restrictions, though customers may find a complete set of covenants to be too much. Since the objective usually is only to establish an early-warning system, simply net worth, leverage or cash flow covenants may be enough. Covenants like this were more common in outsourcing agreements in the period just after Enron's collapse, but faced stiff resistance from suppliers and demand eventually receded. Satyam's failures are stark reminders of the need to manage the risks addressed by these provisions.



• Require periodic financial statements to replace publicly filed statements which may no longer be available or to supplement public filings with more regular or detailed information. For example, monthly cash-flow reporting may be required to back up a minimum cash flow covenant. Requiring on-site audit rights may not be unreasonable if the acquirer's financial transparency is limited. While it may seem obvious, financial reporting and covenants must be focused on the party with which the customer is contracting and any guarantors. Parent company financials are no help if the parent company is not obligated under the contract.



• Escrow key supplier-owned software or alternative protections against loss of critical software in the event of supplier failure. Further, frequent delivery of data and developed code is a key protection against unforeseen events.



• Gain assurances as to continuity of key staff regardless of any reduction-in-force or restructuring.



• Cure ambiguities in scope-of-work definitions to eliminate opportunities for dispute.



• Expand service levels and related performance credits to provide objective metrics for key functions and rapid access to corrective measures.

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