Legal Pitfalls of an Outsourcing Transaction

1. Legal Pitfalls of an Outsourcing Transaction Dr. Marc Hilber, LL.M. (Illinois) CompTIA EMEA Member Conference 2009

2. Agenda • 1. Introduction • 2. Contractual Structures • 3. Outsourcing Services Agreement • 4. Special Issues

3. Introduction • What is outsourcing? • out·sourc·ing (out'sôr'sĭng), n. • Outsourcing is defined as the takeover of a business area or function by a (third party) service provider.

4. Focus onCore Business Cost Savings Balance SheetImpact Market Funded ServiceImprovement Introduction • What are the key drivers for outsourcing? Key Drivers

5. Sale of a business unit (pure M&A) Sale of a business unit + Outsoucing Contract Outsoucing Contract without sale of a business unit Introduction • Bandwith of outsourcing transactions • No or only short-term ancillary services • Transitional Services Agreement • Ongoing service relationship • Typical outsourcing contract • Business unit is closed • Outsourcing without M&A

6. Introduction • Trends in the European market • Market is more mature • off- and nearshoring • right-sourcing • real time delivery • Core capabilities are defined less restrictive • services are more sophisticated (BPO und managed services) • dependency is higher: multi-sourcing • Negative experiences • re-integration or 2nd generation • disputes regarding damages

7. Agenda • 1. Introduction • 2. Contractual Structures • 3. Outsourcing Services Agreement • 4. Special Issues

8. transfer asset by asset prior spin-off checks and balances easier exit global succession Contractual Structures • Strategies for the transfer of the respective business unit • Asset Deal • Share Deal • Joint Venture • Spin-off

9. Contractual Structures • Contracts to be concluded • Contract(s) on the sale and transfer of the respective business unit • Outsourcing services agreement (combined with SLA) • Migration agreement (in case of prior one-off services) • Letter of comfort (in case of special purpose vehicles) • Cooperation agreement (in the financial services sector)

10. Contractual Structures • Interrelations between sale of business and outsourcing services agreement • Starting date • Warranty for purchased assets (business unit) • Liability in case of mal-performance • Remuneration (purchase price) • Termination/Exit • Terminology

11. Contractual Structures • Joint Venture • Subject Matter • Contributions • Financing • Corporate constitution (voting and information rights) • Exclusivity • Exit-options • termination • Put- und Call-Options

12. Contractual Structures • Tax considerations • VAT • Cost factor for banks, insurance companies, and medical services • Otherwise neutral factor • Co-operational provision of sub-services / required assets • Off- und Near-shoring

13. Local Entity Local Entity Principal Service Provider Local Entity Local Entity Local Entity Local Entity Contractual Structures • Multi-national outsourcing: single agreement • Contractual relations only between • holding entities of principal and service provider • which pass on the services internally to their subsidiaries

14. Principal Service Provider Framework Agreement Local Entity Local Entity Local Agreements Local Entity Local Entity Local Entity Local Entity Contractual Structures • Multi-nationales Outsourcing: Framework Agreement • Framework Agreement between holding entities of principal and service provider • Local Agreements between respective local entities

15. Agenda • 1. Introduction • 2. Contractual Structures • 3. Outsourcing Services Agreement • 4. Special Issues

16. Outsourcing Services Agreement • Services • Starting phase: transfer of service responsibility to the service provider • Definition of services • Service Level Agreements (SLA): measurable target values (availability, reaction and response time, training ratio, churn rate, etc.) • “As Is” dispute • Service recipient?

17. Outsourcing Services Agreement • Remuneration • Fixed price, with reduction mechanism • “Cost Plus” model, with maximum ceiling • Price per item, volume-based reduction • Performance incentives (bonus vs. penalty) • Combination of different models, e.g. base rate + volume-price • Price adaptation throughout term • Benchmark • Formula (German legal requirements) • Negotiation (leverage?) • Inflation compensation

18. Outsourcing Services Agreement • Service changes (= change request) Agree as much as possible upfront Supplier can impose certain changes? Customer can require certain changes? Determination of costs (third party)?

19. Outsourcing Services Agreement • Service Management • Measurement of performance and reporting • Communication rules • Single point of contact (Retained Organization - Key Account Management) • Regular meetings (with written minutes) • Coordination / decision making • Escalation procedure / dispute resolution • Information and audit rights

20. Outsourcing Services Agreement • Liability • Impact on business and reputation • Internal risk becomes external risk • Cost of liability insurance  investment in structures to avoid breach • Remedies for violation of SLA • Maximum liability? • Right of redress • Insurance coverage

21. Outsourcing Services Agreement • Termination • Term, renewal clause • Termination for cause • Insolvency • Material breach (definition?) • Change of control • Termination for convenience • Minimum term • „Trial period“ • Compensation payment • Notice period: re-integration or 2nd generation

22. Outsourcing Services Agreement • Exit provisions • Assets to be re-transferred • Use for other customers? • Value? • Contracts with third parties (e.g. software development) • Employees • Right to audit the services + access to know-how/documentation • Confidentiality • Availability of IPRs (in particular software – source code and escrow) • Transition support by service provider • Non-compete clause (committing the principal)

23. Outsourcing Services Agreement • Major Issues - Other • Disaster recovery and business continuity • Exclusivity / minimum volumes • Assignability and right to sub-contract • Group policies and codes of conduct • Applicable law

24. Agenda • 1. Introduction • 2. Contractual Structures • 3. Outsoucing Services Agreement • 4. Special Issues

25. Special Issues • Tax • Outsourcing of accounting services: § 146 AO • In principle, only within national territory • On application also to foreign territory, if access is secured and confirmed by certificate of foreign authority • § 370 AO • Tax evasion in case of negligent supervision • Training in German tax law may be required • § 41 EStG: wage accounts are principally to be controlled at respective business unit

26. Special Issues • Data protection • Technical and organizational measures to protect personal data, § 9 BDSG • Outsourcing = commissioned data processing, § 11 BDSG • Written agreement • Minimum content (in particular, principal‘s right to give directions) • Sub-contractors • Transfer to service provider in other country • Within EU or to safe country: no additional requirements • Otherwise: standard clauses (of EU Commission) for controller–processor relationship

27. Special Issues • Outsourcing in the financial services sector • Financial services regulatory law applies, in particular so-called „MaRisk“ of „BaFin“ • Financial institution remains responsible for compliance • Outsourcing contract must allow risk management • Right to give directions, obtain information and conduct audits  control! • Consent in case of sub-contractors • Insurance companies require authority’s approval • Breach of privacy rights? • Information held by hospitals / certain insurance companies (life, accident, health) • Transfer of secret information only to professional assistant (not: service provider) • Solutions (difficult): technical approach, double employment contract

28. Special Issues • Software • Who uses software – service provider or principal? • If transfer of rights is necessary: transferability of software rights by asset deal? • “Change of Control”-clauses in share deal • Volume licenses • Development of new software during outsourcing term  IPRs?

29. Dr. Marc Hilber Partner Konrad-Adenauer-Ufer 23, 50668 Köln Tel.: +49 (0) 221 2091-612 marc.hilber@oppenhoff.eu