Vendor Contracts 101: Winding Up the Relationship

The final installment in our Vendor Contracts 101 series addresses a topic often overlooked when forging a new vendor relationship: ending that relationship. It may seem pessimistic to think about separating from a vendor before you have even signed a contract, but it is important to plan for that stage of the relationship – after all, few vendor engagements last forever. While it is impossible to plan for every eventuality, it is easy to plan for some of the most common legal and operational hang-ups described below.

Appropriate Termination Rights

First and foremost, making sure the bank has the right to terminate the contract if necessary is critical. Unless the contract is terminable at will (or with minimal notice), at a minimum the bank should have the right to terminate the contract if:

1. The vendor materially breaches the contract and, in certain circumstances, does not or cannot reasonably cure the breach.
2. The vendor goes into bankruptcy or is otherwise financially decimated.
3.  The vendor breaches its confidentiality obligations or suffers a security breach.
4. The vendor assigns the contract to another vendor who does not meet the bank’s third-party risk management standards.
5. The regulators require the bank to cease doing business with the vendor or determine that the bank is out of compliance with applicable regulations because of the vendor’s products or services.

Termination Fees

When reviewing proposed contracts, most bankers already keep a keen eye out for fees or penalties for terminating the contract prior to the end of the term. Such fees have become exorbitant in recent years, and it is now not uncommon to see buyouts of up to 100% of remaining fees in initial agreement drafts. There is often a reasonable compromise to be struck here, so do not be afraid to negotiate.

Termination fee provisions may not all be located in the same section of your contract. If your contract includes any upfront discounts or credits, for example, those provisions may well contain clauses requiring the bank to repay such amounts if the contract is terminated early. Give your documents a thorough read to find any additional (possibly more vaguely phrased) termination costs.

And lastly, pay attention to which types of termination trigger fees. While often characterized as an option for the bank to “terminate for convenience,” you may find that your contract actually calls for termination fees in any early termination situation, which is not necessarily reasonable or appropriate.

Deconversion and Wind-Up Services

Deconversion is a topic often left out of contracts altogether. For some arrangements, there is little to no deconversion work to be done. Others, like core processing contracts, come with a cumbersome deconversion lift. Start the deconversion discussion with your vendor early and get an idea of what to expect in terms of timing and costs so that those expectations can be built into the agreement. Where possible, negotiate contract provisions that set the deconversion fees in advance or at least provide reasonable caps.

Additionally, note that deconversion frequently comes with the need for separate deconversion agreements and nondisclosure agreements among the bank, the old vendor, and the new vendor. When it comes time to review these documents, compare them to the deconversion provisions in the original agreement to ensure there are no conflicting provisions. And don’t be afraid to negotiate – these are not necessarily “one-size-fits-all” agreements.

Hand in hand with deconversion, make sure you understand what other trailing/wind-up services might be needed separate from the actual transition of the operations to the new vendor. Will there be a need to access old records or transaction histories for some period of time? Maybe there will be some overlap or lag in processing as transactions shift to the new platform. In any event, root out what additional assistance might be needed from the old vendor following termination to ensure a smooth transition to a new vendor (and whether any additional fees will apply!).

Destruction/Return of Confidential Information

Most outsourced services and platforms involve the processing, handling, and storage of large amounts of the bank’s confidential information – most importantly, customer information. Contracts should include clear obligations for vendors to return or destroy all confidential information of the bank within a certain (reasonable) timeframe following termination, and these requirements should comply with regulatory obligations (like those found in the Gramm-Leach-Bliley Act and the FFIEC’s Interagency Guidelines Establishing Information Security Standards).

Notice Requirements

Most contracts include provisions specifying how far in advance the parties must give notice to the vendor in order to terminate a contract – and often there are different timeframes for different types of termination. Track down these timeframes, and make sure they are reasonable and operationally doable. For example, are there long notice requirements that will keep the bank in the contract for an unreasonable amount of time following a breach by the vendor? If the vendor gives notice of termination or nonrenewal, will it be far enough in advance for the bank to find a new vendor?

Discussing the unwinding of a relationship before it has even begun is awkward and can feel like a vote of no confidence in the relationship or the vendor’s performance. But having these discussions early and incorporating appropriate parameters into the contract at the outset generally benefits all parties, avoids future misunderstandings, and contributes to a more amicable parting of the ways if and when the time comes.