Unfortunately, few outsourcing customers pay sufficient heed to the "rights and remedies" clauses in contracts, including the fine print about where disagreements will be resolved. "Most customers don't read these issues; they leave them to the lawyers. But they're dead wrong," says Diana McKenzie, chairwoman of the IT group at Neal, Gerber & Eisenberg LLP in Chicago.
U.S. companies have inked hundreds of application development and software maintenance contracts with Indian firms over the past few years, so "the timing is right" for many of these contracts to run into problems, says McKenzie. "And the first place that lawyers are going to look is at this [dispute resolution] clause," she says.
IT managers need to understand that the legal rights and remedies laid out in outsourcing contracts vary depending on the legal jurisdiction agreed to by the parties involved. "Most of our clients would prefer to have their transactions governed by a law in the U.S., such as New York state law," says John Funk, chairman of the outsourcing practice at Jones Day in Dallas. That's largely because New York courts have established legal precedents concerning many outsourcing provisions, and many offshore providers are comfortable with the tenets set by the courts in New York, says Funk.
Kirkland & Ellis LLP, a law firm with 1,100 attorneys in offices worldwide, generally advises its clients to specify in their contracts which state laws they wish to apply for legal rights and remedies, says Gregg Kirchhoefer, a partner in the firm's intellectual property and technology transaction practice in Chicago. Kirchhoefer, who represented General Motors Corp. in the granddaddy of IT outsourcing agreements in its 1984 deal with Electronic Data Systems Corp., notes that some rights and remedies are unenforceable in certain countries. For example, no-compete agreements are void under Indian law.
Be aware that the cost of trying to enforce an outsourcing agreement in court will typically outstrip the value of the contract at issue, says Leonard Nuara, chairman of the technology and intellectual property practice at Thacher Proffitt & Wood LLP in New York. So if an outsourcing agreement should go sour, it's best to have a contract that's laden with multiple exit options, leaving a court of law as a last resort.
For instance, a deal can include provisions that if the outsourcer fails to meet specific service metrics, there will be financial penalties against it or "credits" that the customer can use to purchase other services from the outsourcer, says Nuara. That way, if it's an extensive contract with multiple services being provided, the customer can opt to discontinue the underperforming service without stopping the whole contract, he explains.
If it's an application development agreement, the contract can include exit options across the course of the work being done, says Nuara. For example, if the customer is unhappy with how the provider has completed the development specifications, the contract could permit the customer to award only portions of the actual development work to the outsourcer.
"Don't write your contract like a restricted-access highway, where you can only get off the highway at the end," says Nuara. "There should be lots of exit opportunities along the way."
The arbitration option
Few U.S. outsourcing customers are willing to resolve contract disputes in international courts, because it's cheaper and more convenient to use U.S. courts. Besides, foreign courts can be even more bureaucratic than their U.S. counterparts. "You can raise a child by the time you can get issues resolved in Indian courts," says McKenzie.
But arbitration, a private forum for resolving contractual disputes, is a different story. It's much less formal than a court of law and much more business-oriented in terms of procedure, says Nuara. Judgments are awarded by either a single arbitrator or a panel.
Outsourcing customers that include arbitration in their contracts should stipulate that arbitrators must have specific experience in areas such as application development outsourcing, Nuara says.
The time and cost of arbitration can vary widely. Kirchhoefer says that when parties agree to binding arbitration under their contracts, they typically include a time frame for arbitration to commence and for the decisions to be made. He added that arbitration can often take six to nine months to complete, compared with litigation, which can take years. Arbitration is generally less expensive than taking a case to court, he adds. It can start at a "relatively modest" figure of $100,000, while litigation can go into seven figures.
Although attorneys often advise U.S. outsourcing customers to use domestic arbitrators, they will occasionally agree to arbitration at neutral sites such as London or Geneva that are internationally recognized and also serve as a halfway point for their dealings with Indian providers. "It's easier to enforce an arbitration award in India than it is to enforce a court judgment made in New York," says Funk.
Rather than relying on the uncertainty of litigating disputes in India, where the courts often move slowly and are allegedly subject to manipulation by outside forces, Nuara suggests that the outsourcing parties opt to arbitrate their disputes in the U.S. That's because India is a signatory to a New York convention that provides a legal mechanism for the enforcement of U.S. arbitration in India.
Once a clause for U.S. arbitration has been invoked, Nuara says, the parties involved "know the result will be enforceable."
Sidebar
More prenup tips
-- Spell out that the legal venue you've chosen for resolving disputes is sole and exclusive. If the words "sole and exclusive" don't appear in a contract with an Israeli provider, for example, then Israeli law requires that the case be tried in Israel.
-- Demand a performance bond in the contract, where a third party guarantees a vendor's performance. If the vendor doesn't meet its performance requirements, then you collect on the bond as you would on an insurance policy.
-- Include a clause that allows you to withhold payments if you are dissatisfied with a vendor's performance.
-- Make it clear who the parties to the contract are and whether any subcontractors will be providing services. Also, specify the location where the outsourcer will provide the services, so that you know who's doing the work and where it's being done.