Liability schemes in sourcing contracts

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1 Financial institutions Energy Infrastructure, mining and commodities Transport Technology and innovation Life sciences and healthcare Liability schemes in sourcing contracts A global perspective

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3 A global perspective research Norton Rose Fulbright s Sourcing Team has conducted a review of the liability schemes contracted for in 150 recently negotiated sourcing contracts across key industry sectors. For each contract, the research maps: Liability caps Where liability is capped by reference to annual fees, the general liability cap as a percentage of annual fees; where liability is capped by an aggregate amount, that amount as a percentage of the overall deal value. Indemnities The indemnity scheme across nine types of liability: data loss; IP infringement; regulatory breach; damage to tangible property; breach of confidentiality; breach of licence terms; breach of data security; data privacy breach; and wrongful termination. Excluding and capping types of liabilities Whether liability for types of loss is excluded, capped or uncapped. Research methodology The contracts our Sourcing Team analysed are made up of a mix of outsourcing arrangements (both BPO and ITO), IT implementation contracts (including systems procurement and integration deals), network infrastructure procurement, software licensing and Enterprise Resource Planning (ERP), data centre implementation and hosting, and cloud computing. The research covers regions across North America, Europe, Middle East and Asia Pacific and considers liability schemes in these sectors: Financial Institutions, Communications, Media and Technology, Transport and Energy. North America Europe The Middle East Asia Pacific Norton Rose Fulbright 03

4 Liability schemes in sourcing contracts Strategic insights for business and in-house counsel Norton Rose Fulbright s research shows that, from a global perspective: Executive summary Liability caps Where annual fees caps are used, capping supplier liability to of annual fees remains the most popular percentage, with suppliers in the Financial Institutions sector more often achieving this (rather than some higher percentage) when compared with the other sectors. Where deal value caps are used, they are frequently 30% - 50% of deal value for suppliers across all sectors, but a significant proportion of suppliers cap their liability at more than the deal value. This typically occurs where suppliers exclude liability for losses most likely to arise. Customer annual fees caps and deal value caps are generally lower than the corresponding supplier caps, although mirrored customer/supplier caps are not uncommon. Excluded losses Indirect/consequential losses, followed by loss of profit, are the most commonly excluded losses across all sectors. However, our research reveals that a significant proportion of contracts exclude merely indirect/consequential losses, but not the other losses that might typically arise. This may point to a common misconception among suppliers: that these other losses will be excluded by virtue of the indirect/consequential losses exclusion. Indemnification for and/or capping liability for particular losses Suppliers demonstrate a marked sensitivity in relation to liability for losses relating to data (that is, loss or corruption of data, breach of data privacy/protection laws, breach of confidentiality, and breach of security), in particular where they cannot quantify their likely losses. This is especially so in regulated sectors (such as the Financial Institutions sector) and where the losses that a customer might seek to recover include fines and penalties. Here suppliers often refuse indemnification and/or tend to cap their liability. Unsurprisingly this is also true of regulatory losses. Indemnification for loss or damage to tangible property occurs most frequently in the Transport and Energy sectors, while indemnification for breach of licences granted or for wrongful termination is the exception rather than the rule (and liability for such losses is typically capped). Indemnification for infringement of intellectual property rights is the most commonly indemnified loss across all sectors. 04 Norton Rose Fulbright

5 A global perspective Liability caps Annual fees caps Supplier caps Capping supplier liability to of annual fees remains the most popular percentage. Suppliers in the Financial Institutions sector are more successful than those in the Communications, Media and Technology and Transport and Energy sectors at limiting their liability to of annual fees (rather than some greater percentage). 62% of suppliers in the Financial Institutions sector manage to achieve this result, while only 48% of suppliers in the Communications, Media and Technology sector and 51% of suppliers in the Transport and Energy sectors are able to do this. On the other hand, the frequency with which customers manage to get their suppliers to agree to supplier caps of over of annual fees corresponds quite closely across all the sectors examined: 38% of suppliers in the Financial Institutions sector, 41% of suppliers in the Communications, Media and Technology sector and 40% of suppliers in the Transport and Energy sectors agree to this. In a small proportion of cases in the Communications, Media and Technology and Transport and Energy sectors suppliers limit their liability to sums significantly below of annual fees. For example, 11% of suppliers in the Communications, Media and Technology sector manage to limit their liability to 50% or less of annual fees, while in the Transport and Energy sectors 6% of suppliers achieve this. This contrasts with the position of suppliers in the Financial Institutions sector, where our research shows that suppliers generally cannot achieve this. This outcome reflects both the more risk averse nature of banks and financial institutions and the stronger bargaining position that they have by virtue of scale. Customer caps Customer annual fees caps are typically lower than the corresponding supplier cap across all sectors, but customer caps are sometimes set on the basis of mutuality with the supplier cap. Accordingly 28% of customers in the Financial Institutions sector, 25% of customers in the Communications, Media and Technology sector and 22% of customers in the Transport and Energy sectors cap their liability at over of annual fees. A greater proportion (29%) of customers in the Financial Institutions sector (when compared with customers in the other sectors) manage to keep their own cap on liability at or below 75% of annual fees. Norton Rose Fulbright 05

6 Liability schemes in sourcing contracts Deal value caps Supplier caps Where supplier liability is capped by reference to deal value, it generally results in a lower cap (when compared with caps for liability linked to annual fees). Deal value caps across the sectors are generally merely a percentage of the deal value (typically in the 30% - 50% range for suppliers). However, in each of the sectors a material number of contracts include supplier caps that exceed the total deal value: 15% of contracts in the Financial Institutions sector, 14% of contracts in the Communications, Media and Technology sector and 36% of contracts in the Transport and Energy sectors. While suppliers are understandably reluctant to put the entire deal value at risk (particularly as to do so jeopardises more than the profit component of the deal), supplier caps that exceed the deal value typically occur in contracts where the supplier is successful in excluding liability for the losses most likely to arise as a result of its own breach of contract. In such cases a supplier may consider that it assumes no (or little) additional risk in agreeing a higher cap. Where supplier losses are not generally excluded, suppliers insist on lower caps as a percentage of deal value. In the Financial Institutions sector, for example, 35% of suppliers manage to cap their liability at or below of the total deal value, while for the Communications, Media and Technology sector and Transport and Energy sectors, 30% and 38% of suppliers respectively achieve this. A surprising number of suppliers manage to limit liability to 10% (or less) of the deal value: of suppliers in the Financial Institutions sector, 23% of suppliers in the Communications, Media and Technology sector and 13% in the Transport and Energy sectors. Customer caps Customer caps linked to total deal value typically mirror the cap agreed for the supplier. A significant proportion of customers manage to limit their liability to 10% (or less) of the total deal value: 40% of customers in each of the Financial Institutions and the Communications, Media and Technology sectors, while just 15% of customers achieved this in the Transport and Energy sectors. Customers whose caps are linked to deal value sometimes agree caps in excess of the total deal value. For example, 10% of customers do this in the Financial Institutions sector, while 14% of customers are prepared to do this in the Transport and Energy sectors. As with suppliers, customers are more likely to agree such a liability profile if the losses likely to arise as a result of their breach of contract are excluded. 06 Norton Rose Fulbright

7 A global perspective Excluded losses Many losses not excluded Indirect/consequential losses followed by loss of profit are the most commonly excluded losses across all sectors. Indirect/consequential losses are most commonly excluded in the Transport and Energy sectors. Subject to that exception, all other heads of loss are most commonly excluded in the Communications, Media and Technology sector (when compared with the other sectors). However, our research reveals that, across all sectors, a significant proportion of contracts do not exclude any losses other than indirect/consequential losses. This may point to a common misconception that these other losses will be excluded by virtue of the indirect/consequential losses exclusion. Exclusion of supplier liability for loss of data varies according to sector, and customers in the Financial Institutions sector are particularly successful in resisting the exclusion of supplier liability for such losses. This is because banks and financial institutions operate businesses heavily dependent upon data (including personal data) and are subject to regulatory regimes that require them to safeguard such data from operational risk (including in a sourcing or outsourcing context). Regulatory considerations such as these, in combination with the bargaining power that comes with scale, mean that banks and financial institutions, more so than customers in any other sector, can expect their suppliers to assume risk in relation to loss of data that they cause. Originally an approach adopted by US suppliers, and now increasingly common in Europe and elsewhere, suppliers who are reluctant to assume such liability often require their customers to take on responsibility for data backup. In such cases, rather than excluding such liability outright, a supplier may be prepared to agree to restore the data, but only to the state that existed at the last customer back-up. The supplier can therefore, de facto, limit its exposure under such a provision if the customer fails to comply with its own back-up responsibilities. Norton Rose Fulbright 07

8 Liability schemes in sourcing contracts Indemnification Contractual claims and indemnification differ Indemnity Protection from a specific loss If it can be shown that the loss falls within the scope of the indemnity, the loss can be claimed. The loss need not be foreseeable There is usually no duty to mitigate as an indemnity call is not a claim for damages Liability under the indemnity arises from the contractual term and is not necessarily a consequence of any breach on the part of the party giving the indemnity The loss may be, but need not be, caused by the claims of third parties A claim under an indemnity protects the party from the actual loss suffered An indemnity does not in itself give rise to a right to terminate the contract. Contract breach Damages for breach of contract The loss must be foreseeable There is a duty to mitigate losses Liability for contractual damages arises upon breach of a term of the contract Third party claims may sometimes be too remote to recover in a claim for breach of contract Contractual damages put the party in the position it would have been in had the contract been performed The breach of a certain type of term of a contract may sometimes give rise to a right to terminate if such term is sufficiently fundamental to the contract Increasing supplier resistance to indemnities Suppliers are increasingly resisting giving formerly common indemnities. Where indemnities are given, suppliers are now tending to cap them. Supplier resistance to indemnification is particularly marked where it is difficult for a supplier to evaluate the potential risk or quantify its likely exposure under the indemnity. This is especially so in areas now receiving increased customer-side regulatory scrutiny (and attendant increased risk of regulatory fines and penalties), such as the regulation of financial services and data protection compliance. 08 Norton Rose Fulbright

9 A global perspective Indemnifying for and/or capping liability for particular losses Loss or corruption of data Generally between 33% - 34% of suppliers give an indemnity for loss or corruption of data across all sectors. 27% of suppliers agree uncapped liability in relation to such losses in the sectors, except the Transport and Energy sectors, where the percentage of suppliers agreeing uncapped liability is much lower. Breach of data privacy/ protection laws Surprisingly, our research shows that, across all sectors, suppliers less frequently indemnify customers for breach of data protection laws than they do for many other types of loss (perhaps reflecting supplier concerns about not being able to quantify their likely exposure under such an indemnity). While customers more frequently obtain indemnification for breach of data protection laws in the Financial Institutions and Communications, Media and Technology sectors (when compared with customers in the Transport and Energy sectors), customers in the Financial Institutions sector are less likely than customers in the Communications, Media and Technology sectors to impose uncapped liability on their suppliers in relation to such risk. This may reflect supplier concerns, already mentioned, that find a particular focus in the Financial Institutions sector. Breach of confidentiality Across all sectors examined, supplier breach of confidentiality is, after infringement of intellectual property rights, the next most commonly indemnified risk for customers. Interestingly a significant proportion of suppliers themselves, across all sectors, secure an indemnity from customers in relation to customers breaching confidentiality (typically between 30% - 35% of cases, depending on the sector). This demonstrates suppliers concerns about their own proprietary material. Across all sectors, customers manage to negotiate an uncapped liability on the part of their suppliers for supplier breach of confidentiality in 36% to 49% of cases (depending on the particular sector). Norton Rose Fulbright 09

10 Liability schemes in sourcing contracts Breach of security Customers in the Transport and Energy sectors are the most successful at securing an indemnity from their suppliers in relation to breach of security obligations, at 46% (reflecting the fact that security obligations extend to physical infrastructure, upon which customers in these sectors heavily depend). Across all sectors, customers manage to get suppliers to take on uncapped liability for breach of security in - 22% of cases (depending on the sector), illustrating that uncapped liability for this risk remains the exception rather than the rule. Regulatory losses Predictably suppliers agree to indemnify customers for regulatory losses most frequently in the Financial Institutions sector (when compared with the other indemnities that customers obtain in that sector), followed by the Communications, Media and Technology sector (on the same basis of comparison). In both these sectors customers typically achieve uncapped supplier liability in 40% - 41% of cases (depending on the sector). In contrast, in the Transport and Energy sectors, such indemnities are less common, and supplier liability for regulatory losses is typically capped. Loss or damage to tangible property Customers secure indemnification for loss or damage to tangible property fairly consistently across the sectors in 40% 48% of cases (depending on the sector), but it is most common in the Transport and Energy sectors (where there is typically increased customer dependence on physical infrastructure). However, a different picture emerges in relation to the capping of supplier liability in relation to such losses across the sectors, where the extent to which suppliers cap their liability varies significantly (reflecting different supplier insurance practices in those sectors). 10 Norton Rose Fulbright

11 A global perspective Breach of licences granted Across the sectors, suppliers rarely give their customers indemnification for losses incurred by customers for supplier breaches of licences granted. Conversely, in all sectors examined, a small percentage of suppliers require customers to indemnify them for such losses (ranging between 7% and 10% of cases across the sectors). This reflects supplier concerns that customer misuse of supplier licensed material might put the supplier in breach of its own licences with third parties. Generally such liability is capped, although a small percentage of suppliers and customers in some sectors accept uncapped liability for this type of loss. This shows that this type of loss is not, generally speaking, singled out for separate liability treatment. Wrongful termination The indemnity profile for wrongful termination corresponds closely across all sectors examined, with a low percentage of suppliers (between 9% 12%) and customers (between 4% 12%) giving indemnities for wrongful termination across the sectors. Between 81% - and 85% of both suppliers and customers cap such liability across the sectors, but a small proportion of suppliers (and an even lower number of customers) leave liability for wrongful termination uncapped. Infringement of intellectual property rights Across the sectors this is the most commonly indemnified loss. Where sector variation occurs, it is in relation to the capping of such liability. For example, in the Financial Institutions sector, 23% of contracts leave such liability uncapped for both parties, while in the Transport and Energy sectors, the proportion is just 15%. The variation reflects the concern of customers in the Financial Institutions sector, in particular, over their dependence on technology solutions of suppliers, especially in the outsourcing context. Norton Rose Fulbright 11

12 Liability schemes in sourcing contracts Liability caps global findings by sector Annual fees caps In the Financial Institutions sector, 38% of suppliers capped liability at over of annual fees. In the Communications, Media and Technology sector, 89% of suppliers capped liability at or more of annual fees pH H H H H pH Financial Insitutions 38% Proportion of suppliers Cap as a percentage of annual fees Over 3% 3% 4% 3% Cap as a percentage 7% of annual fees 22% Proportion of suppliers 62% Communications, Media and Technology 41% 40% 4% 7% Proportion of suppliers Transport and Energy 48% 51% Cap as a percentage of annual fees 1-25% 26-50% Over 1-25% 26-50% 51-75% Over 28% 25% 6% Proportion of customers 43% 6% Proportion of customers 59% Proportion of customers 56% 8% 8% 17% 11% Cap as a percentage of annual fees 1-25% 26-50% 51-75% Over Cap as a percentage of annual fees 1-25% 26-50% Over Cap as a percentage of annual fees 1-25% 26-50% 51-75% Over 12 Norton Rose Fulbright

13 A global perspective Deal value caps In the Financial Institutions sector, 55% of suppliers agreed aggregate caps of between 1% and 40% of the overall value of the deal. In the Communications, Media and Technology sector, 30% of suppliers limited their liability to at or below of overall value of the deal pH H H H H H Financial Insitutions 5% 5% 5% 36% 15% 15% Proportion of suppliers Proportion of suppliers 13% 13% 13% 15% 1-10% % 41-50% 71-80% 90-99% Over Communications, Media and Technology 7% 7% 7% 14% Proportion of suppliers 14% 7% Transport and Energy 23% 14% 7% 25% Cap as a percentage of deal value Cap as a percentage of deal value 1-10% % 31-40% 41-50% 1-10% % 51-60% Over 61-70% 71-80% 90-99% Over Cap as a percentage of deal value 15% 5% 10% 14% 5% 5% 10% 14% 10% Proportion of customers 10% Proportion of customers 10% 14% 15% Proportion of customers 29% 40% 40% 14% Cap as a percentage of deal value 1-10% % 31-40% 41-50% 71-80% Over Cap as a percentage of deal value 1-10% 21-30% 31-40% 41-50% 61-70% 71-80% Cap as a percentage of deal value 1-10% % 41-50% Over Norton Rose Fulbright 13

14 Liability schemes in sourcing contracts Most commonly excluded losses global findings by sector Indirect/consequential loss, followed by loss of profit, were the losses most widely excluded by suppliers across all sectors. Financial Insitutions 80% 60% 40% Indirect/consequential Loss of goodwill Loss of business Loss of business opportunity Loss of profits Loss of data Loss of revenue Loss of anticipated Loss of anticipated savings savings Loss of data Loss of goodwill Loss of revenue 0% Loss of profits Communications, Media and Technology 80% 60% 40% Indirect/consequential Loss of goodwill Loss of business Loss of business opportunity Loss of profits Loss of data Loss of revenue Loss of anticipated Loss of anticipated savings savings Loss of data Loss of goodwill Loss of revenue 0% Loss of profits Transport and Energy 80% 60% 40% Indirect/consequential Loss of goodwill Loss of business Loss of business opportunity Loss of profits Loss of data Loss of revenue Loss of anticipated Loss of anticipated savings savings Loss of data Loss of goodwill Loss of revenue 0% Loss of profits 14 Norton Rose Fulbright

15 A global perspective Most commonly indemnified losses global findings by sector Across all sectors, the most common indemnity given by a supplier was for infringement of intellectual property rights. Breach of confidentiality was the next most frequently indemnified loss across all sectors. Financial Insitutions % 60 60% 40 40% % Loss or corruption of data IP Infringement Breach of data privacy obligations Breach of confidentiality Breach of Wrongful data security termination Regulatory losses Loss or damage Breach to of tangible licences property granted Breach of licences granted Wrongful termination Loss or damage to tangible property IP Infringement Regulatory losses Communications, Media and Technology 80 80% 80% % 50 60% 40 40% % % Transport and Energy 80 80% 80 80% 0% % % 40 40% % % Loss or corruption of data IP Infringement Breach of data privacy obligations Breach of confidentiality Breach of Wrongful data security termination Regulatory losses Loss or damage Breach to of tangible licences property granted Breach of licences granted Wrongful termination Loss or damage to tangible property IP Infringement Regulatory losses Breach of data security Breach of confidentiality Loss or corruption of data IP Infringement Breach of data privacy obligations Breach of Breach confidentiality of data privacy obligations Breach of Wrongful data security termination Regulatory Loss losses or corruption of data Loss or damage Breach to of tangible licences property granted Breach of licences granted Wrongful termination Loss or damage to tangible property IP Infringement Regulatory losses Norton Rose Fulbright 15 Breach of data security Breach of confidentiality

16 Liability schemes in sourcing contracts Indemnifying for particular losses global findings (aggregated sectors) 66% of contracts contained no indemnity for loss or corruption of data. 46% of contracts contained no indemnity for breach of confidentiality. No indemnity Customer indemnity only Supplier indemnity only Mutual indemnity H H H H H H H H H Loss or corruption of data Breach of security Breach of licences granted 30% loss or corruption of data: indemnities 30% loss or corruption of data: indemnities 1% 66% 62% 3% Data Privacy Regulatory losses Wrongful termination 25% breach of data privacy obligations: indemnities breach of data privacy obligations: indemnities Breach of confidentiality Loss or damage to tangible property IP infringement 29% breach of confidentiality: indemnities 24% 3% 5% 9% 8% 10% 6% 6% 1% 1% 67% 46% 25% 28% 3% 15% breach of data privacy obligations: indemnities 1% 62% 56% 3% 38% 9% breach of licences granted: indemnities 82% wrongful termination: indemnities 87% 18% IP infringements: indemnities 43% 1% 16 Norton Rose Fulbright

17 A global perspective Capping liability/indemnification for particular losses global findings (aggregated sectors) 79% of contracts capped both the customer s and the supplier s liability in relation to loss or corruption of data. 78% of contracts capped both the customer s and the supplier s liability for breach of data security obligations. Capped for supplier and customer Uncapped for supplier and customer Capped for supplier and uncapped for customer Capped for customer and uncapped for supplier H H H H H H H H H Loss or corruption of data Breach of security Breach of licences granted 6% 2% loss or corruption of data: Capped/ Uncapped 79% breach of security: Capped/ Uncapped Data Privacy Regulatory losses Wrongful termination 10% 5% breach of data privacy regulatory 26% obligations: Capped/ Uncapped 12% losses: Capped/ Uncapped 76% 68% Breach of confidentiality Loss or damage to tangible property IP infringement 1% 26% 13% 11% breach of confidentiality: Capped/ Uncapped 4% 7% 14% 15% 13% 78% 1% 53% loss/damage 26% to tangible 19% property: Capped/ Uncapped 67% 32% 1% 3%3% 7% breach of licences: Capped/ Uncapped 1% 5% 7% 87% wrongful termination: Capped/ Uncapped 87% IP infringement: Capped/ Uncapped 29% 38% Norton Rose Fulbright 17

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20 Liability schemes in sourcing contracts Key contacts Nick Abrahams Partner, Sydney Norton Rose Fulbright Australia Tel nick.abrahams@nortonrosefulbright.com Barbara Li, Partner, Beijing Norton Rose Fulbright LLP Tel barbara.li@nortonrosefulbright.com Marc d Haultfoeuille Partner, Paris Norton Rose Fulbright LLP Tel marc.d haultfoeuille@nortonrosefulbright.com Rohan Isaacs Partner, Johannesburg Norton Rose Fulbright South Africa (incorporated as Deneys Reitz Inc) Tel rohan.isaacs@nortonrosefulbright.com Jamie Nowak Partner, Munich Norton Rose Fulbright LLP Tel jamie.nowak@nortonrosefulbright.com 20 Norton Rose Fulbright

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