The Bottom Line

Navigating the Complexity of Vendor Contract Negotiation 

Posted by Myron Schwarcz on Jan 24, 2018 9:00:00 AM
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Not that they ever were simple, but there has certainly been a notable uptick in the complexity of legal agreements between financial institutions (FIs) and service providers recently.

The driving factors behind this trend are logical­, with the current regulatory environment requiring more aspects of vendor contract relationships to be formalized. Particularly where service providers have access to customer data or support critical operations, enhanced regulatory scrutiny of third-party obligations creates added motivation for both FIs and vendors to limit their exposure. Documenting each party’s responsibilities in detail may help, but in the event of an issue, the hard truth is that customers will look to their FI for resolution, not a back-office provider whose name they don’t recognize.   

At the same time, the number of vendor contracts that must be managed, tracked, audited and benchmarked has increased. This has primarily been driven by the fact that FIs are increasingly reliant on third-party service providers for more and more functions. Much of this growth is being driven by the level and pace of innovation demanded from FIs by consumers. In addition to the increase in numbers of vendors, there is the rise in the hours spent getting these vendors to work together since many of their solutions must interoperate within the IT environment of the bank or credit union.

Most FIs are well aware of these complicating factors. The answer they want is to the question:  what can be done about it? Some suggestions for addressing this challenge are offered below. These suggestions are not magic bullets but will describe a way to start to get the problem under control.

The Home Paper Advantage

In the vast majority of situations, vendor contract negotiations begin using the vendor’s standard template. This is nothing new, and it is often positioned as the most efficient approach to the matter at hand, since the vendor is more familiar with the laundry list of points that should be addressed for a given service. This is a fair point as trying to build out a contract on the FI’s paper can be time consuming. 

However, though this may be the cleanest approach to getting the deal negotiated and the resulting project underway, there is an important point to remember when dealing with the vendor’s template.  Although very few vendors resort to hiding “gotchas” in these documents, by definition, they reflect a perspective primarily aligned with the interests of the service provider. They know better than anyone where those interests are protected.

That said, the answer isn’t to start from scratch, but rather closely review the entire vendor contract. This is no easy task, as contracts can be 150-200 pages with a lengthy glossary of terms. The good news is that there are a few sections that deserve particular scrutiny, specifically any language pertaining to performance obligations, business commitments, financial terms, data rights/privacy, and disputes. Some FIs have elected to use their own paper to document these standard commercial terms and rely on the vendor’s template as the starting point to document the terms specific to the applicable service.

Of course, every contract paragraph should be reviewed and examined carefully due to the complexity of vendor contracts, interactions between various terms, and criticality of the applicable service. Also, remember, the person leading the charge at a FI may negotiate 8-10 applicable vendor contracts in their career, whereas vendors have teams dedicated to  negotiating hundreds or thousands of specific contracts in a year. 

This is why another tactic banks or credit unions are using to reduce the level of complexity in vendor contract management involves using a third party with specific negotiating expertise and accompanying market data to level the playing field with the vendor. Interestingly, many vendors welcome this type of third party into the mix as it can accelerate the process.

Decide What Matters, Invest Extra Time Upfront

Of course, contract diligence hardly ends on signing day. Those responsible for ongoing monitoring almost certainly differ in terms of their goals from those who negotiated the agreement in the first place. The opportunity for leakage during this knowledge transfer is considerable – particularly in agreements so far-reaching that no single employee is likely to have a full understanding of every nuance. We strongly recommend documenting the key points of a relationship very early in the process while they are still “top of mind.”

Create a “cheat sheet” (it’ll probably run 2-3 pages) highlighting the key triggers, deadlines and obligations of both parties (what you need to do, when you need to do it) to simplify ongoing monitoring. Also, keep a running list of experiences and issues encountered throughout the life of the contract to ensure they’re dealt with at renewal.  Some software platforms can automate the workflow associated with keeping track of these material elements within an agreement.

On the Other Hand, Speed Kills

Moving too fast is as frequent a catalyst for creating complexity in vendor relationships as any other factor. Typically, the “speed kills” phenomenon kicks in when a vendor contract is renewed or an addendum is added to an existing agreement.  It is absolutely critical to exercise extreme caution when renewing a contract or executing contract amendments with vendors. In particular, as discussed in a previous blog, addenda can create unintended and substantial changes to the broader agreement. With 200-page documents, and contractual disputes that can hinge on the interpretation of a single comma, the opportunity for such missteps is all too real. 

One last word of advice: before entering discussions, determine your priorities for a given agreement and negotiate accordingly. The reality is that you often cannot get the absolute best price, best service levels and best terms all in the same deal. If a vendor tells you otherwise, you’d be advised to watch your wallet.

Topics: Vendors & Contracts