Legal Research

Risk Allocation in an Outsourcing Contract ? The Game of Hockey

By Joan Chambers and Debra Finlay

Risk allocation is rarely the impetus for entering into an outsourcing, but it is often a critical element in long term, complex outsourcing contracts, particularly where business transformation is involved. Risk allocation can be addressed in an outsourcing contract in the same traditional manner as in any commercial agreement (such as representations, warranties, limitation of liability, and so on). You rarely, if ever, see a provision in the contract that lays out the allocation of risk between the parties. 

So how exactly is all of this related to the game of hockey?

Getting to the Playoffs

The teams have lined up and faced off on the topic of risk transfer throughout the due diligence and contract negotiation phases of your outsourcing deal. The regular season has ended and you?ve made it to the playoffs. The outsourcing playbook is negotiated (the contract is signed) and the allocation of risk is set. But wait, is it really?

Once the contract is signed and your team is at the start of playoff season, the operational players take to the ice to implement the strategy of the playbook. But the strategy of the game for the playoff season is different and it can change very quickly. You have to be aware of the special teams, penalty killers, and, of course, the goons. What you think you negotiated in the contract can be #^&*%$! with just one cross check or errant pass (or something like that). Before you know it, you?ve suffered unintended consequences… SCORE… and your risk profile just changed.

The implementation of an outsourcing is like any great hockey game… lots of passing, checking, a little bit of fighting and a lot of hard work ? and that?s just the day to day business operations of an outsourcing deal.

Your playbook (the contract) is just the start…so, as your team is skilfully passing the puck back and forth and executing on your well thought out playbook, there are a few things you may want to consider.

The Players

Once the outsourcing contract is signed, the initial risk allocation between the parties is determined. But all too often the contract is handed over to the special teams and penalty killers to implement and manage. But those players are not always involved in the due diligence or contract negotiation. As a result, special teams and penalty killers may not have as detailed an understanding of the plays and how they work together, particularly in the area of risk allocation. As well, they may be distracted by the background noise from the stands (running the day-to-day business). The effect is that their actions may have an unintended impact on the allocation of risk in the game and set the other team up for an offensive rush and scoring opportunity.

One of the defensive plays and a way to preserve the initial allocation of risk is to ?operationalize? the playbook with the special teams and penalty killers (who will be managing the contract after it is signed). In the world of contracts, this is more than just diarizing milestones and due dates. The parties both need to plan in advance to meet their respective contractual commitments. In short, they don?t want to come up short – they need to project manage themselves. This applies to both teams, particularly where the matter in question affects more than one line of players (or business units in an organization).

If your line-up includes Kane, Towes, Keith and Seabrook, you probably have nothing to worry about.

The Coach

A strong coach is critical to the success of the team, especially in a complex, long term outsourcing that is based upon business transformation. Without strong oversight to execute on the playbook, there is a risk that the players will not be in position to adapt to the changes on the ice, to pass the puck to their teammates or to defend against the goons. A good coach will have the players functioning as a well integrated team… each knowing his/her role and contributing to the overall success of the team.

Avoid the Penalty Box

High sticking, charging, hooking, interference… beware of the potential ?gotchas?. The ?joint approach? to governance and decision making is a potential ?gotcha? that can land you in the penalty box and leave your team short handed if you are not careful. It is common in an outsourcing to use a post-signing governance structure that is based upon joint committees (for example, a joint operational committee, joint executive committee and joint program office). The ?joint approach? is predicated on the parties jointly reviewing, discussing, considering and often agreeing and approving deal issues as and when they arise. While the joint approach may be, and usually is, critical to good governance and the success of the relationship, it can also supplant the contractual rights and obligations of the parties and may result in an inadvertent re-allocation of risk and one that was never part of the playbook.

This joint decision making can be an effective means for transferring operational risk from one team to the other, or at a minimum, result in a sharing of that risk. This can manifest itself in unexpected change orders, requests for additional funds for operational support, expansion of scope or other increased costs arising out of the joint decision of the parties. The responsibility of the risk for such decisions is rarely discussed at the time the joint decision is made. These joint decisions and approvals can occur at any level of the organization, and be deemed to be accepted through unknowing acquiescence and subsequent conduct of the parties. The artful deke.

The Trades

Last year they were playing for your team… but this year they are playing for the other side. The trades!  You may be able to manage them but you may not be able to prevent them. When the trade happens the balance of power shifts. Knowledge and skill sets that are essential to your strategy may just have switched teams. All good playbooks have a defensive non-solicitation strategy and strict rules on trade eligibility to manage the risk of trades. 

The Free Agents

Recognizing the importance of continuity for the ongoing success of the team and the chance to win the Stanley Cup, efforts should be made to minimize turn-over from year to year, particularly in the initial team building years. While promotions, being put on waivers and other turn-over are inevitable, maintaining consistency of your players (in particular your stars) will help to ensure you stay in the game. 

Game Misconduct – The Call of the Referee

To say that the responsibility for risk should rest with the party best suited to manage it is nothing new. An unreasonable allocation of risk will affect the value proposition of the outsourcing. This can happen intentionally through specific contract provisions or unintentionally through the conduct of the parties after the contract is signed. So when you get to the playoffs, consider how your team?s conduct will affect the outcome of the game… risk allocation and the transfer of risk need to be carefully addressed in your playbook and continually monitored throughout the game. Failing to do so might just land you with a game misconduct call by the referee. That game misconduct penalty might carry with it an automatic fine and an appearance before the Commissioner (or the court or an arbitrator) who shall have full power to impose such further sanctions. 

Full post as published by Slaw.ca on June 25, 2010 (boomark / email).