Avoiding costs when changing contracts

6 October 2011 | Adviser Q&A

I am migrating a number of small service contracts to one large facilities management contract. The contract terms state I could be liable for high termination costs if I cancel existing deals. What advice can you give?

Head of procurement, Nottingham

Qusharat Hussain, director of supply chain, Morrison Facilities Services

The priority is to understand exactly what those termination costs comprise of and the extent of their liability. To do this you will need to engage and discuss with your current suppliers.

Remember that liability certainly exists if such costs have been mentioned, discussed and or agreed pre- or post-contract, otherwise it would be the responsibility of the suppliers to demonstrate and justify such costs to you.

To mitigate or defend such instances you can use the following:
• Which party’s terms and conditions are in force?
• When do the current contracts expire? If you are proposing an early end to switch contracts then you would expect costs to be higher.
• Are costs ‘reasonable’? Again, the length of contract, timing and notice to terminate can help to mitigate.
• You could request the supplier demonstrate any steps taken to ensure why these high costs have not been alleviated or reduced.
• Any claim for redundancy or staff costs may fall under TUPE. It is a specialist area and you should consult with your HR expert to see if it applies.

Martyn Sherrington, head of procurement,
SGP Property and Facilities Management

When moving to a single provider of FM services, you need to harness the experts in the process, such as the new FM provider. It will be experienced at migrating smaller contracts whilst mobilising your new service.

Moving to a new provider does not mean that existing providers need to be terminated on day one. Talk to them and seek to strike a fair deal for both parties.

Contracts that have a high termination cost or have already been prepaid by you should be novated to the new provider, so they can manage the service from the supplier as part of your contract.
The new provider may want to continue with the supplier if they provide a good service, or if they want to exit they may have more negotiation leverage than you.

Consider the cost of exit for each deal and ensure you’ve read the contract terms – seek legal advice if needed. If the termination costs are high you could consider continuing with the service and managing it yourself and removing that element from the new contract.

Philip Dews, commercial manager, Interserve

It is always a difficult decision to terminate when a contract provides for recompense in the event of early termination and should be a lesson to all purchasing professionals when preparing and entering contracts.

Before carrying out a detailed analysis of the situation, it is important to identify on whose terms the contract has been entered into. There may be documents to suggest that the supplier has a claim for early termination, but are these documents the ones to which the contract is bound to?

If it is proven they are binding, then it is important to understand what the termination cost will be, whether it is legally enforceable (is it a penalty, or a genuine estimate of loss should the contract be terminated?) and what the opportunity cost is. The opportunity is more than just the actual service costs and should make allowance for the reduction in management costs associated with a large number of service providers.

Migrating smaller contracts to a large single contract is never easy, but the rewards will often outweigh the initial cost (in time and money).