Contract Exit Strategies

Increasingly volatile markets and growing supplier dependency have combined to make contract exit strategies far more relevant and important than they were in the past.

The drivers for contract exit may be planned or unplanned. They range from factors such as financial distress or reputational risk, through to changes in market conditions or disinvestment.

Contracts have always had termination provisions, typically allowing early exit for non-performance and increasingly perhaps including some form of ‘termination for convenience’. The extent to which specific consequences of termination were spelt out has tended to vary, but again our contracts are likely to have specific obligations or survival clauses. But are these still adequate and should companies have more thorough approaches to their exit planning?

These were questions that a group of IACCM members sought to answer during a conference call last week. The conversation included practitioners from a number of large global corporations, as well as some experienced consultants and law firm partners. The group agreed that the consequences of exit – whether voluntary or involuntary – have become far more significant today, due to the heightened dependence on key suppliers (for example, in areas such as core software, IT systems and outsourced relationships). However, most felt that exit activities still tend to be handled on an ad-hoc basis, rather than through a well-defined or consistent process.

There appeared to be four major challenges facing those who would like to improve the quality and consistency of exit planning:

• It takes time – and the business is unlikely to accept delays in getting to contract caused by planning on how to exit
• It is not practical to consider every eventuality
• Rights of exit carry a cost; suppliers need to gain recovery so early exit can have severe financial implications
• In many cases, the business concludes that exit is not practical and allows contracts to run their course  or undertakes specific renegotiation

However, these obstacles do not eliminate the desirability of having some form of exit plan in place. Various suggestions were made about ways to develop and manage this:

• Checklists based on past experience should be developed
• Checklists or plans can also be documented based on ‘reverse engineering’ the original transition plan
• Include plans – and their update – into the annual planning process, including option analysis
• Review existing contract models; where exit rights may be important, consider this within the original contract structure (eg asset ownership, software license ownership) as well as within relevant terms (eg data management, escrow provisions, obligations to assist transfer)
• Incorporate exit planning into the risk management and review process. For example, the relative risk associated with a particular product or service should be guiding supplier selection – not only in terms of their reliability, but also the level of future negotiability.
• Proactively negotiating a new and more detailed termination agreement once the actual situation is known – rather than solely relying on the more hypothetical and more general provisions of exit arrangements negotiated in the original agreement

In general, suppliers are not averse to discussing exit plans and their readiness to do this – together with the quality and integrity of the process they follow – could be a significant factor in supplier selection.  However, a level of specificity may be difficult to achieve because there are too many hypotheticals – what’s the basis of termination, what’s the relationship like, how full or how partial the termination is, whether services are going to one new supplier (external or in-house) or many new suppliers. 

Some interesting points to consider when thinking about exit plans included the need to recognize that many terminations are not absolute; they may cover only part of the relationship, or they may result in a phased wind-down of service. In many cases, it may be possible to transition the supplier to a different project, thereby alleviating resistance and financial implications. Factors such as these significantly affect the nature of any negotiation at the time of an exit. In addition, the consequences of exit can vary between industries and geographies; as an example, it was suggested that in Europe, employees normally transfer back in the event of the customer terminating an outsourced service, whereas that is less commonly the case in other geographies. Another influence that was discussed was the impact of a mutually agreed exit, versus a contentious exit; in the latter case, the plan should allow for the need to switch the relationship management and performance teams, since they will rarely have positive views of each other and cooperation (which will be crucial to smooth transition) is unlikely to be achieved.

Overall, there was agreement that companies should seek to record and document lessons learned; that it is wise to have more in-depth planning for key strategic relationships; that these plans should be reviewed and updated on at least an annual basis; that exit planning should be an inherent element of risk management and mitigation; and that checklists of key points to consider are valuable and can potentially be applied across a wide range of contract relationships.

(My thanks to Richard Hawtin, partner at Baker & McKenzie, for his valuable contributions to the original discussion and this summary)