Outsourcing agreements: spotlight on step-in rights


Author: Tim Wright


Tim Wright, Partner, Fladgate LLP (twright@fladgate.com)


 

It was recently reported that the Ministry of Justice (MoJ) has terminated an outsourcing contract with G4S. The termination of the 15-year contract, awarded to G4S in 2011, comes after the MOJ was forced to step-in and take over running the HMP Birmingham in August 2018 the prisons watchdog concluded that the prison was “exceptionally violent” and “fundamentally unsafe” with staff “living and working in fear”. The step-in was supposed to last six months but this was extended for a further period before the parties’ mutually agreed to bring the prison back under permanent MoJ management.

G4S has agreed to pay £9.9m to cover the MoJ’s extra costs of taking over the prison, including the costs of hiring extra staff. G4S will work with the MoJ to transition the prison’s management over the next few months, with G4S’s staff at Birmingham due to transfer their employment to the prison service on 1 July.

Construction and development contracts

The concept of a contractual right to step-in originated in construction and property development projects. In this context, it is common for a collateral warranty or schedule of third party rights to include a right for the beneficiary of the collateral warranty (often a funder) to step in and take over the developer’s contractual rights as employer of a building contractor or a professional consultant, following a serious and unremedied breach by the developer or the developer’s insolvency. Step-in rights may also permit the employer to step in to a subcontract where the main contractor becomes insolvent.

Outsourcing and step-in

In an outsourcing context the services are typically provided on an ongoing basis, compared with a construction or design project where there is a pre-agreed end point following completion and handover. However, the right to step-in operates a little differently; generally speaking, a step-in right allows the customer to step-in and take over the outsourced operations if the supplier cannot or does not perform and, once the supplier is able to demonstrate that it will be able to meet its contractual obligations, the customer steps-out.

Public Sector

The Crown Commercial Service’s Model Services Contract[1], which is intended for services contracts with a value over £10 million, contains a robust step-in right in favour of the contracting government entity (Authority). This is in addition to the Authority’s other contractual remedies, which include the remediation and rectification plans, service credits, delay payments, the appointment of a remedial adviser, termination and other remedies relating to supplier non-performance. Equivalent rights of step-in also have to be flowed down into each Key Subcontract.

The events which can give rise to the right to step-in are not limited to the supplier’s contractual breach but include no-fault triggers including circumstances the Authority considers to be an emergency, as well as the Authority’s need to discharge a statutory duty or where advised to step-in by a regulatory body. The step-in clause permits the Authority to step-in itself, or (subject to confidentiality) engage a third party to do so on its behalf, and take other control of the outsourced services or part of them. The supplier must bear its own costs in connection with the step-in, which will include the development of a step-out plan, although where the step-in was not a result of the supplier’s default, it can recover the reasonable additional expenses which it incurs as a direct result of the step-in.

Business-to-business

Step-in rights have been included in major outsourcing and other business-critical services arrangements, especially in regulated sectors such as financial services, for many years. They can be contentious and key points for negotiation include defining:

  • the step-in triggers. As with the Model Services Contract, if the triggers include events such as force majeure or other events which are not, of themselves, fault-based, the supplier will argue for a different financial treatment in terms of its ability to recover loss profits as well as costs and expenses which it incurs as a result.
  • how the step-in rights will be exercised and operated, what are the roles and responsibilities of the parties, how will a step-out plan be developed, tested, approved and implemented (e.g. through a phased hand-back), and over what period should the step-in last.
  • other consequences of the step-in, such as the effect on the Charges and providing the supplier with relief against performance remedies (e.g. services credits) in respect of the stepped-in services.

Practical issues

Traditional outsourcing models, where services are provided to the customer on a dedicated basis, better lend themselves to step-in as an appropriate remedy where the supplier’s service performance is failing to meet contractual standards and requirements. Today, with the advent of cloud computing and with outsourced services increasingly provided through shared infrastructure and facilities with non-dedicated staff and third party technology, exercising traditional step-in rights becomes much more difficult and in some arrangements, may never (or rarely) be appropriate. As a result, some outsourcing contracts will dispense entirely with step-in rights; alternatively they may be heavily modified with more emphasis on enhanced customer monitoring, oversight and remediation, often managed by an independent third party (sometimes appointed at the bequest of a number of affected customers).

Stepping in

Customers should think very carefully before stepping-in. Other contractual remedies may be more appropriate; alternatively without prejudice negotiations (perhaps under the contract’s escalation and dispute mechanisms) may lead to a better result. Where the customer decides to step-in, the relevant clauses should be carefully considered as part of the planning phase, and the engagement of any third party to assist will need to be coordinated in alignment with the expected step-in timescales. Where regulated, the customer’s operations and compliance teams will have to work closely with their supervisory counterparts (e.g. at the FCA or PRA).

The decision to terminate the MoJ’s contract with G4S suggests that despite the parties’s best efforts, the step-in was not, ultimately, successful, although the decision to take back the management of HMP Birmingham into Government control also has political connotations.


[1] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/781059/Model-Services-Contract-v1.05-England-Wales.pdf


 

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