Outsourcing contracts & Brexit : Impact

Having just completed a heavy-lifting exercise involving the Client Risk Assessment of over 40+ contracts for a global Outsourcer, it is clear that the Outsourcing Market is facing some interesting challenges.

This 40+ contracts were merely a sample set to identify the scale of problems that may occur given recent political decisions. My client is already somewhat ahead of the game in both assessing and planning for the transition/changes as they impact contracts in flight. My role was to validate, challenge thinking and objectively nudge them in the right direction.

Scope

The assessment exercise covered two main political shifts that impact cross-border trade for global firms - Brexit & US H1B Visa. This post focuses upon some brief highlights of the Brexit review (H1B will follow shortly).

I needed to understand what impact Brexit could have upon my clients existing contracts - Are any contracts at risk? Could any contracts be no longer viable for either party? What consideration and action is required to safeguard future revenues from in flight deals?

Brexit

Lawyers often sway from wearing rose tinted spectacles or dressing like the grim reaper. During a relaxed debate with some in-house lawyers at 50,000 feet, we discussed whether Brexit could actually be deemed a Force Majeure event - it was totally unexpected, certainly not predicted, no provisions made in the contract by either party, its impact on the performance of contracts or the doctrine of frustration may well be legitimate. In all contracts the financial impact of Termination for Convenient or Force Majeure will differ for each party, and could influence how analysis of options are interpreted.

Moving away from the topic of Exit - how about understanding the issues that just need fixing if the contracts are to be given a chance of survival?

Largely a UK/European issue, there is the real potential for tariffs to be applied between the UK and EU. The inherent cost impact could seriously cast doubt over some contracts, rendered unviable.

Likewise, whilst early political debate suggests that free movement will be impaired post Brexit, the UK government has suggested it would be many years before the UK could pick up the reigns of foreign workers.

My assessment looked only at contracts currently in flight - the assumption being that new contracts could more easily cope with the risk and ambiguity that Brexit brings, and any renewals over the next year or two would likewise be adapted, picking up on the same nuances of new contracts.

I outlined some commercial/contractual considerations/risks that needed to be included as part of the assessment:

What if Exchange Rates shift?

Any self-respecting negotiator has dealt comfortably with currency/exchange rate mechanisms for years. Over the past decade, the Sterling and Euro exchange rates operated within close proximity, so it was often not a priority to cater for significant swings. Most negotiators focused upon the US Dollar and Indian Rupee as being more volatile. Some commentators fear the UK's exit could trigger broader unrest and stimulate political appetite across other member nations for a freer Europe, where financial stability could be compromised.

What if Tariffs are imposed?

The prospect of new tariffs is real and should be modelled by vendors and clients alike to determine where the respective pain points are.

Many law firms have developed assessment tools and suggest that renegotiations take place to incorporate a review mechanism allowing vendors to adjust the price of goods should tariffs be introduced. I struggle with this at a practical level.

Tariffs are taxes on the 'buyer' imposed by Government to make foreign goods more expensive.

Today, Vendor charges Client £100,000 and makes an acceptable margin. With a 20% tariff, the vendor still receives net £100,000, making the same margin. The client has paid a 20% premium and government has collected the 20% by way of taxation.

In reality, if the relationship and contract is at risk, the parties have no real alternative than to discuss 'if' it makes viable sense to continue as is; should scope be changed; could partial termination for convenience limit the fiscal impact of tariffs?; can the vendor absorb some of the pain that the client will feel? Many options can be considered, but the point is that through many lenses, tariffs will be counter-productive. Suppliers will lose business, customers will pay more and at the end of the day, consumers will pick up the tab.

What if there is a change in Law? 

It is unlikely that the UK legal environment will alter significantly upon Brexit, but deviations with EU law are likely over time. Where existing contracts rely upon UK or EU law, collaboration should allow any future risks to be either borne by both parties or potentially give rise to a Termination for Convenience should the impact move beyond certain acceptable risk thresholds.

Other considerations

It is likely that corporate structures could change post Brexit, with planners already weighing up options. Major financial institutions have voiced concerns about retaining HQ functions in London and suggest they could move thousands of jobs to the EU. If jurisdiction changes occur, clients and vendors must be wary of where the contractual home is from a legal perspective.

Of course, if free movement is in any way thwarted, the pace of relocation will be delayed in order to manage risk and continuity. In time, skills will be lost, jobs created in the EU and jobs destroyed in the UK - costs increase. Whether the threats of relocation are real or not, consideration must be given to the potential cross-border activities, especially in highly regulated industries where until now they have ben harmonised, but in future may simply deviate.

We can expect contracts to be transferred (in whole or in part) to new vehicles that may have been established purely to mitigate the risks of Brexit. It is possible suppliers without a global footprint will create affiliate relationships with local players to continue delivery of services. This brings fresh complexity and governance issues, but is manageable.

What about Data?

It is likely that Data Protection will remain very closely aligned across the UK and EU. The very nature of cross-border business requires the transfer of vast amounts of data between the EU and the UK, and policy makers are keen that processes and systems pass the adequacy test.

For UK businesses wanting to trade across EU member states, compliance with the General Data Protection Regulation (GDPR) will be a prerequisite enshrined in contracts.

What about People?

In many Outsourcing deals, The Transfer of Undertakings (Protection of Employment), otherwise known as TUPE was regarded as legislation that allowed clients to offload significant risk to a supplier. If the UK achieves a hard Brexit (no pseudo EU membership such as EEA), then the implications on TUPE are potentially very real. Existing agreements could be subject to legal challenge, amendment or even repeal of the TUPE provisions.

In all likelihood, one can assume that a 'form' of EEA will be in place to allow continued movement between the UK and EU, but the impact of the contrary should be modelled and discussed between the parties. The potential for redundancy increases hugely in this post Brexit world. If Trade Unions have not yet jumped on this as a potential opportunity/risk, they soon will.

Scope of Contract Assessments

Assessing the impact of Brexit on Primary contracts is the first primary task, but it is also essential that the supply chain for any subcontractors and the inherent risks are well understood. A supply chain risk assessment will identify weak links. For all contracts;

• Does the agreement provide a mechanism to allow the parties to find a workable way forward or is a new process to be defined and agreed?
• What is the likelihood that either party would prefer to seek termination for convenience or Force Majeure (if an option)?
• Who 'contractually' currently picks up the tab for any additional costs? What scope or appetite is there to ensure the 'fairness test' is considered?

In reviewing each contract, those 'technical' positions will likely be easy to identify. The challenge is engaging with the other party to explore more options that enable the relationship and contract to continue.

• Ensure there is an adequate mechanism for exchange rate fluctuations that is fair
• If Tariffs are imposed, complete the full assessment and consider what options fit as discussed above - even considering exit rather than losing money.
• If there are changes in Law, ensure the implications are well understood and undertake a revised risk assessment
• Post a predicted 'hard Brexit', be very aware of the fiscal implications should TUPE be challenged

In delivery, it is recognised that tariffs could well alter investment milestones in the out years, and the potential for resourcing challenges require significant consideration and time to plan/execute - with undoubtedly additional cost implications. 

Nobody predicted the need to renegotiate on terms such as Brexit. Deciding how to deal with the impact requires clear thinking. Next steps must include entering into dialogue on the natural pinch points - a conversation whilst tensions are low and emotions are still calm. Collaborate now to avoid future conflict.

Brexit will really test the strength of client/vendor relations, as both are potentially injured parties.