Outsourcing: How to Avoid Contract Disputes

For all their verbiage and legalese, outsourcing contracts can be surprisingly general and vague, leading to disputes between outsourcer and customer. To quickly resolve conflicts--and avoid costly litigation--consider the following six recommendations for buttoning up your outsourcing contract.

By Stephanie Overby
Thu, June 23, 2011

CIO — Outsourcing relationships are long and complex—the contracts that establish them seemingly more so. Yet for all their verbosity, many outsourcing contracts are filled with generalities and open questions, which can present major problems when conflicts between outsourcer and customer inevitably arise.

"One of the goals of outsourcing contracts is to develop a smooth working relationship between customer and supplier," says Brad Peterson, a partner in the business and technology sourcing practice of Mayer Brown. "When contract language is unclear, the parties develop different interpretations of the contract and those differences lead to disputes."

Disputes, of course, can hurt performance, and the compromises required to resolve them can leave both parties unhappy.

Uncertainty in the contract can also lead to litigation. "Where the potential outcome is reasonably certain to both parties, they usually can reach an agreement on how to settle the matter and avoid a trial or arbitration," says Robert Kriss, a partner and litigator at Mayer Brown. "If the potential outcome of a dispute is uncertain, the parties may evaluate their positions very differently, making it difficult to settle."

Both sides lawyer up—digging through old emails, unearthing draft contracts, and interviewing witnesses—and that racks up billable hours for attorneys on both sides.

Outsourcing customers can mitigate the risk of costly disputes by insisting on clarity at the time the contract is executed and at the first sign of trouble, say Peterson and Kriss. Anticipating all the issues that may arise during an outsourcing relationship is difficult, but drafters of outsourcing agreements should try to address as many specific problems as possible upfront to save money and heartache later.

"You need to prove what promises the parties intended by the agreement, whether those promises were kept, and who is responsible for failures," Peterson says. "The more you think about problems of proof as you are drafting the contract and governing the relationship, the fewer costly factual disputes will arise after the contract is executed."

In other words, think like a litigator at the negotiating table. Here are six tips for buttoning up your outsourcing contract.

1. Provide Specific Examples of Damages

Outsourcing contracts may state that the parties can recover only "direct damages," not "consequential" ones. But case law is unclear about what constitutes direct versus consequential harm, says Peterson. Outsourcing customers should provide specific examples of what they consider direct damages, such as the cost of having the work performed by another provider, and what they consider consequential damages, such as lost profits.

2. Avoid Open-Ended Terms

Many outsourcing contracts state that the parties will attempt to reach agreement on an important provision after signing. That's a mistake, according to Kriss, who advises clients to avoid leaving contract provisions unresolved for two reasons. For one, the parties may not be able to reach an agreement. For another, he says, a court or arbitrator may be reluctant to impose a term without guidance in the contract.

"If such a[n open-ended] provision is unavoidable, consider stating in the contract that the parties agree to an arbitrator or industry expert supplying the missing agreement after hearing the parties' arguments and such decision will be binding and non-appealable," Kriss says.

Alternatively, if the contract does not specify a process for supplying the missing term, it should at least state what happens to the validity of the rest of the contract if no agreement is reached.

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