Technology Contracting and Industry Consolidation – A Continuing Issue

June 26, 2008

Consolidation in the software and technology services industry continues to be a fact of life. Corporate IT departments and the lawyers who support them should be vigilant in structuring their transactions to account for these ongoing and sometimes disruptive changes.

Two years ago, prompted by substantial indications that a major outsourcing vendor, Computer Sciences Corporation (CSC) might be sold, we commented on best practices for planning for changes in control. Though that transaction didn’t materialize, last month, Hewlett-Packard (HP) signed an agreement to acquire Electronic Data Systems (EDS) creating, according to industry sources, the second largest outsourcing vendor in the marketplace. The new organization should provide a new top tier competitor in the outsourcing marketplace and provide customers with additional options for their outsourcing transactions. While additional competition among large scale outsourcing providers could be a positive development for companies pursuing new outsourcing initiatives, disruption, or at least uncertainty may be in the offing for existing transactions.

Reprising and updating our advice from 2006 (see “Taking Control of a Change in Control”), here are several best practices we recommend:

1. Termination Rights; Access to Key Managers and Information. Make sure your outsourcing contract allows you to terminate the agreement (in whole or in part) upon the occurrence of a vendor change in control without the payment of exit fees. While the HP-EDS transaction brings together companies of equivalent stature, there can be no assurance that a new buyer of your vendor will be one to whom a corporate IT executive wishes to entrust his or her companies’ life blood. A termination right upon a change of control will, at a minimum, foster the meetings with the right people and access to the relevant information, to give a clearer picture of how this change in control may affect your organization.

2. Assignment Clauses. Require your prior written consent to any assignment of the agreement by the vendor and be sure that this provision includes changes in control, or consider restricting some worst case assignment scenarios, such as finding your outsourcing and IT operations in the hands of a competitor.

3. Key Personnel Provisions. People determine the success or failure of outsourcing relationships. Make sure that your agreement calls for continuity of key vendor personnel, and effective transitions where changeovers occur, regardless of an external event such as a change in control. You may also be concerned about your vendor’s ability to retain its staff following the merger or other change in control transaction, either due to layoffs, reassignment or voluntary resignations. You can gain additional protection by negotiating a right to terminate without exit fees or by negotiating a service level commitment that provides you with monetary credits if staff turnover reaches a certain threshold.

4. Non-Exclusivity Provisions. Sign a contract that allows you to hire other vendors to do similar work. You will want to avoid any contractual obstacles to bringing in a new provider if you conclude that your current provider is no longer the right partner.

5. Location of Performance. Geographic location of performance isn’t just about geography. Economic issues, security issues and public perceptions all pervade the question of whether a corporation’s work is performed locally or in other locations around the country and the world. Following a vendor change in control, your new provider’s organization may want to use remote or overseas resources and your contract should be structured to give you say in those decisions.

Helping our clients plan ahead for the long term lifecycle of an outsourcing agreement is one of the services provided by the McGuireWoods Outsourcing & Technology Transactions Practice Group. This practice group is part of the firm’s integrated Technology & Business Department, which provides legal services for business transactions driven by technology. These service areas are led by Department Co-Chair Steve Gold.