Contract Corner: Technology Transformation in Outsourcing Agreements (Part 1)

Morgan Lewis - Tech & Sourcing
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Morgan Lewis - Tech & Sourcing

Transformation is often a critical component of outsourcing and managed services transactions. The transition of core or non-core functions to a third-party provider can provide an opportunity for the customer to leverage the service provider’s expertise and experience to transform its underlying systems to more modernized and flexible technology. For instance, a customer running a business platform on old mainframe technology may want to move off the mainframe to a cloud solution that enables the customer to better respond to market needs and offer enhanced services and products to its clients.

In our representations of customers in outsourcing transactions, we have found that when there is a major transformation component, it can require significant time and engagement from key members of the deal team. The drafting of the overall transformation methodology, individual transformation projects, and related contract documentation typically becomes a substantial project in and of itself.

In this Contract Corner, we outline important topics and points to consider when documenting the overall transformation methodology and individual transformation projects. This Part 1 focuses on the overarching methodology exhibit. The following list includes key topics and issues to consider when drafting a transformation methodology that is designed to cover the initial transformation as well as any future transformation.

  1. Structure and Objectives. At the outset, consider the structure of the transformation and the key objectives. If there are transformation projects scheduled to start as of the contract effective date, a list of key objectives helps to set guidance for what the parties are trying to achieve. Are future transformation projects contemplated by the commercial model? If so, a structure will need to be put in place to govern the process for entering into future projects, including documentation requirements, milestone requirements, and payment-related provisions.
  2. Overall Planning. High-level and detailed project plans are critical to ensuring completion dates and deliverables are integrated and met on time. Projects will typically include an initial high-level plan (e.g., a Gantt chart) that outlines the overall timeline of the project. Consider including an integrated high-level plan to help stakeholders view the transformation timeline holistically. In addition, detailed and integrated plans are important to include as one of the first major deliverables. These plans typically require the customer’s approval and include the responsibilities of each party, readiness activities, anticipated completion dates, milestones, deliverables, and acceptance criteria.
  3. Governance. Transformation governance is an overarching function that spans all projects (present and future). A key component is the formation of a transformation management team that is responsible for coordinating and managing the overall transformation approach and that is responsible for the success of the transformation. Careful thought should be given to staffing and retention requirements for key personnel. In addition, the core governance processes should be outlined, such as finance management, contract management, and issue management.
  4. Reporting. Although each project may contain specific reporting requirements, consider what reports are required at a higher level. It is common to include a weekly status report with items such as performance against the high level and detailed plans, progress relative to anticipated completion dates, milestone and deliverable status, risks and issues, proposed changes, and the impact of such changes. These status reports can then feed into discussions at a weekly governance meeting.
  5. Acceptance Process. Due to their varied nature, the specific acceptance criteria applicable to deliverables and milestones are typically included in the individual projects. However, the transformation methodology is a good place to establish the acceptance process, such as deliverable review periods, procedures for correcting nonconformities, and rights and remedies if the provider is not able to make a correction or complete a deliverable on time.
  6. Milestones and Payment. Payment structure will likely be the most heavily negotiated piece of the transformation methodology. Aside from total compensation, the structure of how and when the money gets released is a key driver in incentivizing timely performance. As we have discussed before, there are many options for structuring payment, such as milestone payments, fixed fees, and not-to-exceed amounts. Other options include amounts at risk and credits for milestone defaults, enhanced credits for extended misses, and holdback amounts. Regardless of which option is chosen, appropriate reference to the pricing documents should be included in the transformation methodology so that all contract documents tie together.
  7. Other Rights. The methodology exhibit can also include other overarching rights of the customer with respect to all transformation projects. Consider what rights there are to suspend, delay, extend, or reschedule timelines, especially if projects are scheduled over multiple years. If the service provider is embedding its proprietary or third-party software and tools into the deliverables, consider what license or exit rights the customer should have with respect to such software and tools.
  8. The Definition of Done. The overarching methodology exhibit is likely the appropriate place to outline the requirements for completing transformation projects. This important topic will be addressed in a future post later this month.

Our next post in this Contract Corner series will discuss specific considerations and issues for documenting individual transformation projects.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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