Governing Service Provider Relationships: Seven Legal Tips For Strengthening And Leveraging Contract Rights (Podcast) – Contracts and Commercial Law

Too often, contract rights bargained and paid for in
negotiations are eroded during governance. This podcast describes
seven tips for governing service provider relationships in ways
that leverage or strengthen contract rights. Reg Goeke, who leads
our Commercial Litigation practice, provides a litigator’s
perspective and Brad Peterson, who leads our Technology
Transactions practice, provides a sourcing lawyer’s
perspective.

Transcript

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Julian:

Hello and welcome to Tech Talks. Our topic today “Governing
Service Provider Relationships: Seven Legal Tips for Strengthening
and Using Contract Rights.”

I’m your host, Julian Dibbell. I am a senior associate in
Mayer Brown’s Technology & IP Transactions practice.
I’m joined today by Brad Peterson and Reg Geoke. Brad leads
Mayer Brown’s global Technology Transactions practice. Reg
co-leads Mayer Brown’s Litigation & Dispute Resolution
and Commercial Litigation practices. We have a transactions guy and
a litigation guy.

And today, I am going to talk with them about ways to
effectively govern service provider relationships after contract
signing. Brad and Reg have worked with numerous companies to get
sourcing deals back on track, and they’re here today to help
with some advice for contract governance teams on how to stay out
of trouble and what to do if trouble finds you. Now, Brad and Reg
have in fact shared with me a lovely laminated card listing the
seven key tips on dealing with this problem, and we are going to go
through each of those one by one. But, I want to start by talking
about the fundamental problem or set of problems that these tips
are trying to address. Brad, can you frame the problem for us?

Brad:

Thanks, Julian, and hello, everyone. Julian, the way I’d
frame the problem is as follows:

• Lots of time and money are spent negotiating and drafting a
  contract




• The negotiating team then hands the contract off to a
  governance team




• The people managing the relationship are not familiar with what
  the contract says, and they do not understand how their
  communications and conduct might affect the company’s legal
  rights




• As a result, the contract gets weaker over time, contract
  benefits are lost, disputes arise that could have been avoided,
  disputes result in losses that could have been wins.

By contrast, the best practice is to act in ways that actually
strengthen the contract during governance.

Julian:

Reg, from your litigators’ perspective, how do you view
the problem?

Reg:

Thank you, Julian. I agree with Brad. As a litigator, in
troubled deals, we see many of the same repeating elements. These
include problems and issues with the service are discussed but
aren’t documented, so we have little to point to if the
company wants to exit the contract or initiate a dispute resolution
proceeding. Further, bad documents and communications exist because
the people who are not familiar with the agreements write
communications for the company, often creating what’s
referred to as a “course of conduct” argument for a
vendor that weakens the company’s position. And finally, the
supplier which is sometimes failing to deliver the required
services will often see what is happening faster than the company
will and starts to position the discussions, or use ambiguous
contract terms, in ways that are going to favor the vendor in any
disputes.

So, as a result, it’s harder than it should be build a
case, and that makes it easier for the supplier to just ignore a
legitimate customer request.

Tip 1: Control Messaging and Contractual Communications

Julian:

That sets it up for us, let’s head into our seven tips to
protect your deal. Starting with tip number one – control
messaging and contractual communications. Brad, what do we mean by
that?

Brad:

Julian, a smart service provider will do what we lawyers call
“forum shopping.” They look for friendly or at least
pliable people at the company to at least win concessions from. And
large-scale sourcing deals often involve dozens of stakeholders,
and many of them are executives who would be allowed under
corporate protocols to waive breaches or graded contract
modifications. So, we recommend that as a first step you designate
in writing all employees authorized to speak on behalf of your
company for purposes of the contract. Ideally, that designation is
right in the contract. But if not, you can strengthen your contract
after signing by sending a notice to the provider.

The notice doesn’t need to be fancy, it can be simple:
“Dear Service Provider, We are writing to notify you that
__________, _________ and _________ are the only employees of the
company authorized to sign change orders, work orders, approvals,
waivers, or other documents under our contract. Communications are
only binding if provided to one of us in writing.”

This sort of notice doesn’t need to be a surprise to the
provider, and this is not a hostile act. Every company, when
it’s doing its internal operations, seeks to clarify its
decision rights and approval rights. So it makes equal sense to do
so externally with service providers.

Tip 2: Require a Log of Supplier Requests and Company
Failures

Julian:

Good advice. Tip two – require a log of supplier requests
and company failures. Reg, help us understand that one.

Reg:

When work doesn’t get done in a complex commercial
agreement, the supplier’s best excuse is that the company was
at fault somehow. And there’s a particular danger in
contracts that have broad language about partnering, collaborating,
or cooperating. The supplier can say, for example, that the
customer should have done more to prevent the failure so the
failure to deliver was really the customer’s fault. When we
hear that, we look at the contract and we are hoping to find as
litigators some language that says that none of provider’s
failures will be excused unless provider notifies company of the
problem, gives company a chance to fix it, tries to perform despite
the problem, and verifies that the problem caused provider’s
failure. Whether that’s there or not, it’s good to
notify the provider that it must quickly identify in writing to an
authorized employee any of the company’s actions that might
excuse a provider obligation. You want the provider to know that
it’s your expectation, that they are going to provide you
that information, that is what the provider is supposed to do.

To catch problems early, another good practice is to require
that the supplier maintain a log showing its requests to the
company and the company’s responses on contractual matters.
This prevents the company from missing problems that you had
chances to fix. And it also prevents the supplier from conjuring up
reasons after fact for its failures. The log should be on a shared
site that provides alert messages about the changes and, also, it
should be discussed on a regular basis in meetings between the
company, whether that’s daily or weekly.

Tip 3: Keep the Written Record as Clear, Complete and Accurate
as Possible

Julian:

Tip three – keep the written record as clear, complete and
accurate as possible. Now, Reg, when we talk about the
“written record” here, what exactly do we mean and why
is it important?

Reg:

As a litigator, the way I view most complex contractual
disputes, they are usually won or lost based on the written
communications. People’s memories obviously fade over time
and litigation is usually conducted years afterwards. Or, more
often the case, people’s memories are conveniently colored to
favor their perspective. Often, clients will tell us that the
arrangement with their vendor is not working well, but then we ask
for details, and they struggle even to identify the specific
failures, and they often don’t have any documentation to
support the claims of those failures, or the delays by the vendor
in addressing those failures. So, the first part of the equation is
simply having written evidence of the problem and the
communications about it.

The second part of the equation is making sure that the
documentation is accurate and complete. Often, when we do have
written communications with the vendor, the person from the company
may have made concessions, such as extending deadlines, or agreeing
to less-than-complete service, or may have acquiesced to the
vendor’s interpretation of its obligations in the contract,
or may have described only part of the issue.

This is typically because most people want to be cooperative
problem solvers or to work with the vendor to solve problems.
It’s fine to do that but it is important that the
documentation make clear what the full problem is, and what the
company views as the vendor’s obligations. If the solution
deviates from what is contractually required, that should also be
documented, preferably in a change order.

Julian:

So keeping the written record clear, complete, and accurate is a
good north star for businesses. How do you put that in practice?
Brad, what are some ideas for keeping things clear, complete, and
accurate?

Brad:

Ideally, your record starts with a clear, complete, and accurate
contract. And that’s well worth investing in. But, any
long-term services contract is going to be incomplete in important
ways. You just don’t have time in negotiations to get all the
details right before signing, and you get new information as the
contract progresses. Often there is even a transition period with a
designated knowledge capture phase. And, realistically, there are
always ways to improve the contract. So, the question is how to
keep the record as clear, complete, and accurate as possible. And
ideally to strengthen your contract by having it become more clear,
more complete, and more accurate as you go forward.

A first step is to decide what documents are going to be created
as contract documents and where you will store them. Reg, earlier
mentioned that you should have the supplier maintain a log showing
its requests to the company and the company’s responses on
contractual matters. In addition, you might decide that there will
be amendments, work orders, requests, deliverables, reports,
invoices, and email correspondence. But that’s the whole set
of categories of records that you intend use for the contract. You
then identify a very standard format for each of those so that
it’s easy to search for them in your systems and find a way
to make sure that each one is drawn into the right storage
location. Finally, implement processes to drive the relevant
information into those types of records. Do everything you can to
make sure that, for example, there are records for oral
conversations and if you do send an email, for example, you blind
copy that email to an email box, which is designated as a
repository. It’s going to take a lot of time up-front to
develop these good processes, but these will pay off tremendously
in lower costs and ease of governance and administration when you
do need to examine the record, or when you bring in someone like
Reg to seek to resolve a dispute in a favorable way. Also, it will
reduce costs because the supplier knows that you know the deal
well, and thus will work more carefully and more consistently to
make sure the deal goes well.

Tip 4: Send Timely Breach Notices

Julian:

Tip four – here is an interesting one – send timely
breach notices. Reg, what do we mean by sending a timely breach
notice and why does that matter?

Reg:

What we mean by sending clear written correspondence and timely
breach notices is sending such notices at the first reasonable
opportunity that the company considers the vendor’s conduct
to be a contract breach. If you followed step three, which was
maintaining written communications, there are already going to be
communications with the provider making the provider aware of the
problem and the provider’s responsibility.

But often that’s not enough. Many provider contracts
require formal notices of breach, where they require the provider
be given an opportunity to cure the breach. Providers will argue
that the email communications between its team and the
company’s team are not sufficient. Or, they will claim that
the conduct did not arise to a breach, because if it had, the
company would have given it notice. Or, the provider will, at the
least, insist on restarting the clock on its opportunity to cure
the breach from the time a formal notice is sent. Some contracts,
including one I was reviewing just last week, require notice of
breach within 30 days of its occurrence. The failure to give that
notice can result in waiver claims by the vendor. There are a
variety of legal doctrines that the vendor can use –
including estoppel, waiver, latches, and so forth – to argue
that the breaches should be excused for lack of timely notice. So,
it is important to send formal breach notices when they occur.

Julian:

Okay, but this sounds pretty straight forward, send a breach
notice when you notice the breach. Why is this a key tip;
what’s the problem here?

Reg:

The problem really deals with human interactions. We find that
often clients decide that conversations are sufficient. They have a
meeting with the vendor, the vendor promises to address the
problem, and people often feel like it’s too formalistic to
do more than that. And as a result, little documentation is sent
around after the meeting is done. And months later, the company is
frustrated but has little to point to.

Further, many people in those meetings often feel that sending a
formal breach notice is too confrontational. They have personal
relationships with the vendors and the personnel they are working
with on a daily basis, and they don’t want to create a tense
relationship. So, for those reasons, they will often end a meeting
and conclude that they are good to go and don’t need any
further documentation.

Julian:

You mentioned, Reg, people feel like this could be too
confrontational; is that a concern, Brad? Maybe from the
business’ perspective, isn’t it going to feel like a
hostile act all by itself, like you’re lawyering up or
pulling out the contract on the provider?

Brad:

Yes, it’s a great concern and I agree with Reg that that
is often the number one concern on whether you are going to send a
notice or not. The solution to this, I think our best practices,
clients, send formal notices all the way through. If they send a
formal notice in the middle of a hot dispute, it looks like
lawyering up and it looks like you’re pulling out the
contract. But if you’ve always been sending notices or you
started sending notices on a regular basis when thing were going
well, and you say management asked us to begin to send notices, it
just looks like ordinary course, and it doesn’t disrupt the
course of the relationship. In fact, it becomes part of the fabric
of the relationship.

Reg:

The other point I want to jump in to say, Brad, is that you
don’t need to make the notices hostile. You can explain to
the vendor personnel that the company has a policy, for example, of
sending out formal notices of breach, and that the notice will
reflect any agreed-upon corrective activity. The notice itself can
simply describe what’s happening or not happening, what
contract terms are that apply, and the risk to the company and the
ask of the vendor. So, for example, I pulled out an example of a
recent notice. I genericized it a bit, but it says:

Dear [Provider Relationship Manager]:

We learned recently that you are not encrypting our data in transit
between your facilities. That encryption is required by Section
13.2 of our MSA and Section 7.5 of Exhibit 2, of our Information
Security Policy. //so, now this letter notice has notified them
that there is a breach, it also notifies them of the specific
provisions that have been breached. It will go on to say
that… //This breach could expose us to regulatory action,
loss of data, reputational harm and other damage. //so,
you’ve told the vendor of the risk is to the company. And
then the notice might go on to say…// You have told us that
you will begin to encrypt all data with 10 days and will confirm to
us in writing that you have done so. Please do contact me with any
questions.

So now you have a very cordial and professional letter –
it doesn’t feel like you’re calling in the lawyers. But
you’ve communicated there is a breach, what the provision is,
the impact to the company, and what is agreed upon for the vendor
should be doing.

Tip 5: Before Doing the Provider’s Work, Demand that the
Provider Do Its Work

Julian:

Tip five – before doing the provider’s work, demand
that the provider do its work. That’s a little bit
mysterious. Brad, what do we mean by this? How does this come
up?

Brad:

Julian, I agree. This seems mysterious, but it happens
surprisingly often. It’s a common fact pattern. The provider
fails to do work or does it badly. The work is important to the
company, so the company picks up the slack, does the work, like
they would if it was an internal colleague. The company then asks
the provider for something off the price or short pays the invoice
because the customer did the provider’s work. The provider
comes back and says well obviously the work was not in scope, as
demonstrated by the fact that the company did the work itself. So,
by failing once, the provider manages to create almost a long-term
waiver of what would otherwise be in-scope work. Or, the provider
claims that the company’s doing the provider’s work,
badly or in an uncoordinated way, prevented the provider’s
performance, which caused the other problems. So at least saying,
maybe the provider has a waiver for the immediate instance and a
claim.

Julian:

Okay, so a familiar scenario. Now that you have laid it out,
what then do we do about it?

Reg:

The critical point, Julian, is that you don’t add resources
or assume direction of a provider’s work under a contract
without demanding a cure and warning of the cost. So, again, you
want to provider a written notice and an opportunity to perform. A
notice might read something like this:

Dear [Provider Relationship Manager]:

I am following up on my notice of last Thursday regarding the
lack of management talent and specialists required by Section 12 of
SOW 14. Unfortunately, the problem has not been corrected. If it is
not corrected within 10 days, we intend to add resources from our
own team to make up for delays. These team members will be doing
work that you agreed to do within the fixed price, and thus we will
deduct their fully loaded cost from any future milestone
payment.

Now you’ve given the vendor notice of the potential
breach, what you are going to do, what it’s going to cost
them, and you get around arguments the vendor might have regarding
waiver and course of dealing.

Tip 6: Trade Waivers for Future Assurances

Julian:

Tip six – trade waivers for future assurances. Brad, what
do we mean by that?

Brad:

You’ve got a sort of dispute, the vendor has admitted that
it did badly, but it wants to be back in the position where it
doesn’t have a claim hanging over its head. The common
approach is to have a meeting, get a sort of apology, a personal
promise to do better, call it good, and move on. Or maybe there is
an email and you write something like, “Okay, let’s do
better in the future.” The governance team, of course, wants
to be nice. The open issue is awkward, and everyone wants to move
on. What we would advise instead is that you grant a formal waiver
of the breach only for promises that make that breach less likely
to happen again. So you might, for example, agree to waive the
breach in exchange for an obligation to do a root cause analysis of
the breach, correct any fundamental promises – you might say
that there additional time to perform, but limited additional time
to perform – and you might ask for other similar concessions
to avoid broader problems.

Julian:

It’s an interesting approach, but isn’t the whole
idea of contract law that when there’s a breach you collect
some money?

Reg:

Well Julian, in theory, you could collect money, which might
motivate future performance. But the court and the provider will be
more impressed with the value of the obligation if you focus on
assuring future compliance. Also, as any litigator will tell you,
damages are generally contractually limited in ways that make them
hard to assess or collect. Finally, it’s going to be easier
to maintain a good operational working relationship if the
conversation about an operational failure is about an operational
solution and not about who’s going to pay whom what.

I would note that the reason to have a policy of getting further
assurances in exchange for waivers is also the alternative, which
is most likely, doing nothing. Once you go down the path of doing
nothing with respect to breaches, you risk, as I mentioned before,
a course of conduct argument or a waiver argument – that the
course of conduct somehow defines the obligations so that you
agreed that the vendor do nothing and no longer needs to perform.
It’s much better to insure that some corrective steps are
taken so that you can establish a good record to show what the
course of conduct is supposed to be and what the expectations
are.

Tip 7: Involve Lawyers Early

Julian:

Tip seven – our final tip, last but not least –
involve lawyers early. Other than the fact that we’re lawyers
and we like being involved, why?

Reg:

Contracts are often very detailed, often very clear, about what
each party is supposed to do in normal times. Thus, what I find is
that a lot of clients, particularly the business folks and clients,
will lose sight of the fact that these contracts often say little
about how disputes are going be handled. For that, contracts
typically rely on statutory and common law, rules of contract
interpretation, judges, and arbitrators. So, even when people
believe they know what the contract means, other interpretive rules
can often have an effect that is not anticipated. Or, unbeknownst
to the company or the individuals working on the contract, a
provision in a different portion of the agreement may raise an
ambiguity about how the contract was intended to work. Or, in the
alternative, the words used to deal with breach in a contract often
mean something different or require interpretation. So words like
“material breach” and “consequential
damages,” for example – those words have defined legal
meanings that are often unknown to non-lawyers. And, of course, if
that isn’t enough, as the lawyers in the audience know,
contracts are hard to enforce even in the best of times. So,
it’s important to make sure that early on you understand the
areas in the contract that might be used by the other party in a
dispute.

Julian:

Brad, what are some specific examples of times when a contract
governance team should bring in the lawyers? What’s
“early” for this purpose?

Brad:

Let me offer a few examples. First, involve lawyers before
responding to a significant breach. And that might be when a
milestone is missed or when more than one service level is missed
over the course of a two-month period, or the provider’s
performance is failing to meet expectations, whether or not
you’re sure that it’s actually breaching the
contract.

Second, involve lawyers when you realize that you might be
amending. For example, when there is disagreement or uncertainty
about which party is responsible for a particular action or whether
a charge is correct on an invoice that may be leading to an
amendment. Certainly before approving any detailed plan, desktop
operating procedures, or other documents that change who does what
under the agreement, even if it’s just adding detail. Get the
lawyers involved before a decision is made.

Third, involve lawyers on any of the legal topics, probably the
obvious one, indemnified claims, for-cause termination, and so
forth.

Fourth, involve lawyers when you’re not going to follow
the six prior tips. If you think of these as rules that you should
follow unless you’ve talk to a lawyer about why you are not
doing it. That would be good guidance for when to come and talk to
the law department or talk to outside counsel about what would be
best to do. In each of those, and the other examples, there is some
sort of decision point, an opportunity to improve your position
under the contract, and also an opportunity to risk making your
position under the contract worse – an opportunity to
strengthen your contract or an opportunity to let your contract get
weaker. And you want your lawyers involved before you make the
decision, with enough advance time to collect facts and give sound
advice. In doing so will help you build a stronger contract,
maximize value, and avoid costly pitfalls.

Closing

Julian:

Great advice, Brad and Reg. Thank you so much for coming in
today and sharing these 7 tips and related principles. Listeners,
if you have any questions about today’s episode – or if
you would like your very own copy of the laminated card I mentioned
before, listing the seven tips that Brad and Reg have just talked
about – please email us at [email protected].
Thanks for listening.

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