Categorizing and Resolving Issues in Outsourcing Markups

Introduction

One of the fundamental tools in an outsourcing lawyer’s toolbox is the ability to categorize and resolve issues in a markup. Proper categorization of issues allows the lawyer to prioritize discussion of certain issues over others and direct the negotiation team’s focus on the issues that matter most in an outsourcing agreement. By proposing practical solutions to those issues in light of their importance, the lawyer helps the team more quickly reduce the number of issues that might keep them from entering into the agreement at all.

The skill of categorizing and resolving issues has always been important, but it matters more than ever in today’s legal environment. Outsourcing lawyers are under pressure to deliver results in less time, given that cost reduction is often the primary purpose of outsourcing and there has been a trend towards increasingly complex deal structures. Negotiation teams no longer have the budget to spend hours on every issue in a markup. Instead, business teams expect that their lawyers highlight the most important issues for their attention so that they can use their limited time and resources more efficiently. The nature of the business, its internal processes, the jurisdictions involved, and the context of the transaction will all influence how issues in an outsourcing transaction are categorized.

Identifying and Categorizing Issues

An outsourcing deal typically opens with the sending of the initial documents to the other side followed by the first markup in response (for example, when the potential provider of an outsourced service is responding to a RFP auction draft authored by the customer). The responding party is often thorough in its markup, highlighting a great number of issues in the deal documents. However, the number of issues alone does not give the lawyer an understanding for how far a deal is from getting to done. The outsourcing lawyer’s business team will want to know in particular whether there are any positions in the markup that, if not reversed or mitigated, will cause the team to advise not signing the deal.

Identifying those critical positions begins with a careful review of the entire document or set of documents in the markup—scrutinizing the language used, the definitions, and the responsibilities and obligations of each party—to identify all potential issues created by the counterparty’s changes.

In running a request for proposal (“RFP”) or auction process for an outsourcing transaction, there may be template documents that can assist with understanding the concerns of the business even before sending a document out for markup. For example, a preliminary questionnaire completed by a member of the deal team can be used to reveal important deal terms, including both factual detail and primary objectives, and an interview checklist can be used in follow-up discussions to examine in more detail the items raised in the responses to the questionnaire. These template documents, and the primary objectives identified by utilizing such documents, may already clearly indicate some of the concerns that will be considered material in categorizing the issues.

For those issues not already identified as a material concern (or primary objective) before the markup is received, further efforts will be needed to categorize them properly. Critical issues that require immediate attention, and those that may be negotiable or of lesser importance, will require different approaches. For a typical outsourcing transaction, we generally divide issues into three broad categories (keeping in mind that different deal structures may call for different categories):

1. Deal breakers. “Deal breaker” issues touch on aspects of the agreement that are crucial to the operation of the service or product or relate to significant legal or operational risk to the business. Typical deal breakers include, for example, disagreements on the types of losses covered by an indemnity, the types of damages available, or the amount of, or exceptions to, a liability cap. As the category name suggests, these are may be issues of such high importance that they that must be resolved on the business team’s preferred terms or the deal will not go forward.
2. Issues for clarification. These are issues that relate to material risks but are of a lower priority for the business, or issues for which there are multiple acceptable compromises that could be discussed.
3. Minor issues. These are issues where the risk created either is low enough to be acceptable or could be made acceptable with only minor changes to the counterparty’s language. For example, questions regarding notice formalities or agreement structure typically fall into this category. These issues may be dealt without the need to discuss such issues on a call, for example in writing between the parties.

In some cases, there may be objective criteria that can inform this categorization. On some deals, for example, we have seen businesses set a materiality “threshold”, where the estimated dollar value of the risks associated with an issue (assuming a worst-case outcome) determines the category for that issue. More often, businesses take a more subjective approach, which is not to say that in those cases lawyers are left to rely on their gut to categorize the issues. There are several key questions that can be asked to give an initial indication of categorization (each answered in consideration of the context of the transaction). Among the most important of these questions are the following:

Does the issue involve regulatory or legal risk?

Issues relating to potential legal or regulatory risk are most likely to be deal breakers and should be considered high priority. In particular, indemnity and liability provisions frequently give rise to deal breaker issues because of their impact on the overall risk of a transaction.

Provisions relating to regulations that are under particular scrutiny by regulators, media, or the general public at the time of negotiations may also become deal breakers. Think, for example, of the regulatory issues and attention currently surrounding data protection, financial services, and environmental, social, and governance (ESG) concerns.

Additionally, a business may have already identified specific regulations applicable to the business (or the particular outsourcing context) and may view even minor amendments to its standard language on these regulations as a deal breaker. For example, for facilities management deals, businesses may be particularly concerned with applicable regulations on the outsourcing of hazardous chemicals control, or in relation to a financial services entity, regulatory guidelines on outsourcing may apply and require specific controls.

Does the issue affect the functioning of the service being outsourced?

Provisions that are likely to affect the day-to-day functioning of a service are more likely to generate critical issues, particularly where the service being outsourced is material to business operations or key back-office functions. Although service-related issues are often commercial in nature (think of issues involving the scope of the services or the number of authorized users of a software platform), provisions affecting the availability of a service may have legal considerations that turn them into deal breakers. For example, because service levels (along with related provisions, including the impact of service level failure and any service credits) will typically impact the ongoing availability of a service, inadequate service level provisions may become a deal breaker if the affected service relates to a significant legal obligation such as payroll or data security.

Term and termination provisions also may rise to the level of deal breakers insofar as they go directly to the future availability of the service. Short notice periods for termination, or any termination for convenience, may be unacceptable where a service is material or hard to replace with an alternative supplier.

Responding to Issues

In addition to identifying and categorizing issues, the outsourcing lawyer needs to propose practical solutions to address the related concerns. These solutions should reflect any initial priorities and may be dependent on the context of the transaction, the relationship between the parties, and the course of ongoing negotiations.

First, the identified deal breakers and other material issues should be discussed internally with the deal team, ensuring that they fully understand any legal risk and the implications in context. This step is essential as it enables participants to understand the significance of each issue, and helps to ensure that expectations as to the negotiation strategy and outcomes are aligned across the deal team.

Second, before initiating discussions with the counterparty, providing written feedback to the counterparty may be useful as it will allow them to consider their position in advance (and get approvals where necessary). Following providing written feedback, any discussions are likely to be more productive, or alternatively the counterparty has an opportunity to indicate that there are several issues still open to be considered in more detail. If the counterparty then responds with similar or the same language as before for an issue, it identifies the issue as one that is material that should be discussed on a call.

In comparison, for issues that are less material, it may be more efficient to discuss these with the counterparty in real time on a call rather than providing detailed written feedback; for example, where the intent of the drafting is unclear and the wording simply needs clarification or minor amendments.

Any written feedback to a counterparty should be clear, concise, and well-documented, addressing each material issue raised in the markup. If tracked changes are being used, they should remain visible until an issue is resolved, and any comment bubbles should be marked “resolved” rather than deleted so that they may be referred to on an ongoing basis, similarly footnotes can be marked “agreed” with the date. Where new comments are being inserted into existing footnotes or comment bubbles, it may be useful to include clarifying context (for example, by starting the new comment with a line identifying the person or party that added the comment and the date on which it was added (“Mayer Brown note made on January 8 call:”)). If tracked changes are not used during a call with the counterparty, providing a full redline against the correct version after the call is essential to avoid miscommunication as to what markup has been accepted.

Documenting Issues In some cases, a business may require a summary of all legal risks associated with a transaction covering any material contractual provisions that were negotiated and the outcome of the negotiations, for example with respect to internal approvals prior to signing. To this end, setting up an issues tracker at the outset of a transaction may be efficient, as risks or outcomes can be recorded cumulatively in real time, rather than re-constructed through review of older document versions. Whether implemented in a spreadsheet or a document table, the tracker may also be sorted quickly and automatically by priority (or level of risk), or for a complex contractual structure, by document. Similarly, we have seen some businesses require a higher level summary from a negotiation team as to the approach taken to key risks or priorities. At the conclusion of negotiations, proper categorization of the open issues allows for business leaders to weigh the risks between issues and choose next steps accordingly, including whether to sign a deal, continue negotiating on critical issues, or negotiate with other vendors to get better terms on particular issues.

Conclusion

In summary, there are a number of simple methods by which categorising issues identified in a markup, and documenting them, can improve the efficiency of an outsourcing transaction. Correct categorisation, documenting these issues and documenting how their negotiation is resolved, can support each stage of an outsourcing transaction. In particular, in setting initial expectations across the business (or with a client), supporting effective and practical negotiation, and assisting the business in understanding outcomes and deciding whether to continue negotiations with the counterparty.