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Using proactive remedies to solve outsourcing contract problems

Businesses and outsourcing suppliers often face problems that cause commercial harm but are not serious enough to merit using contractual remedies, which are usually confined to damages claims or contract termination. 

Traditional contractual remedies like this fail to take account of how dependent businesses are on their suppliers. Simply ending a relationship could be crippling – businesses need another way of addressing problems.

Using proactive remedies is one possible solution. This involves putting a framework in place that defines a wide range of events or circumstances that could cause problems and provides a structure for managing the business risks by using tools other than contractual remedies such as damages or termination. It also recognises that problems can occur that are not the fault of either party, and that these problems still need to be solved.

Not only are traditional remedies of little practical use in many cases, they also tend to be reactive rather than proactive – the customer has to wait until it can demonstrate that there has been a supplier default before it is able to activate what remedies are available within the contract.

By contrast, proactive remedies are designed to prevent key business and service risks becoming realities. The risks do not necessarily need to relate to supplier breaches and are designed to focus the parties' minds on good contract and risk management before things go horribly wrong. 

All manner of circumstances can negatively affect a customer's business or the outsourcing relationship - a corruption scandal affecting a key sub-contractor; a major profit warning; a large scale redundancy programme. Each party therefore would benefit from a heightened level of awareness and proactive handling by both customer and supplier.  A proactive remedies regime provides a framework for this to happen from the moment the contract goes live. 

Proactive remedies as a form of 'super-governance'

Everyone agrees that good and robust contract management, which is often called governance, is critically important to the successful delivery of outsourced services and to the good health of an outsourcing relationship. Contracts, however, sometimes pay lip service to governance and contain little more than a list of governance bodies, terms of reference and meeting schedules. 

It is all too common for the parties, over time, to neglect the essentials of good contract governance with the inevitable result that poor performance goes unaddressed or that real business risks, perhaps unrelated to supplier performance, are not anticipated and managed.  With a good proactive remedies mechanism, the parties will have a pre-agreed process for keeping an eye on the issues that matter most to the business.

How proactive remedies work

Traditional remedies are generally activated on identification or notification of a service breach.

Proactive remedies can be structured so that risks outside the control of both parties can be contemplated and prepared for. They can also be structured to address minor breaches, particularly where it is useful to shine a spotlight on situations that can ultimately impact on the relationship in an important way if not fixed, but for which it would not be practical for commercial reasons to rely on traditional contractual remedies.

How to structure a proactive remedy

To be useful, proactive remedies must be tailored to the customer's business; they should be industry and context specific. Proactive remedies are usually drafted collectively as a schedule to the contract or can be built into the contract governance or performance management regime.  To ensure the regime remains relevant to the customer's business, there should be a mechanism for review and updating on a regular basis.

The contract should set out the following:

Trigger events

In thinking about which risk events to address, customers should ask: in addition to service breaches, what events would negatively impact on our business? Consider, for example, bad press; reputational issues on either the customer or the supplier side, including those that affect key subcontractors; downward trends in customer satisfaction surveys, and strikes or emergencies.

Risk levels

A proactive remedy should be set in proportion to the level of risk to which the trigger event exposes the customer. The remedies to address particular risks when they are still at a relatively low level may be as simple as enhanced monitoring or an investigatory report, perhaps at the customer's cost. If those risks escalate, however, the risk level may increase to the next level. The contract should identify the circumstances that will constitute the different risk levels for the purposes of the regime.

A series of remedies

The remedies that apply in a proactive remedies regime should be tailored so that they are effective to address the risks that are identified by the parties. They may include:

  • a requirement that the supplier provide detailed information and/or plans about the trigger event;
  • a discretion for the customer to choose to appoint an independent third party consultant to audit the supplier's business in relation to the event;
  • the initialisation of a bonus scheme for named members of the supplier's personnel to incentivise swift resolution of the situation;
  • for high level risks that relate to service delivery, if the risks have not been addressed by effective action on the supplier's part when the risk levels were low, termination or step-in rights for the customer.

Proactive remedies can help customers and suppliers focus on risk management as part of the contract governance regime, and they can address the general concern that contracts focus on mechanistic and legalistic remedies.  They are tools which supplement traditional contractual remedies rather than replacing them and can be useful in highlighting issues that could impact on a customer's business beyond service breaches.

Contact: Bridget Fleetwood, Legal Director for Pinsent Masons +44 (0)20 7490 6302