Contracts - It’s All About the Fine Print!

Posted April 26, 2017 by Stephen D. Heckard in From the Experts.

I have a recurring nightmare that I will come back in my next life to practice contract law. I do not have a law degree, so hopefully that will minimize the chances. However, reviewing contracts is a significant part of my everyday duties, whether managing a core vendor evaluation or renewing a contract with an existing vendor. Since ProBank Austin has a very active Investment Banking Division, from time-to-time, I review client contracts or a target institution’s contracts to determine departure costs if acquired. My assignment is to specifically review a departure from existing processing agreements.

Have you read your processing agreements lately? Do you understand them? I’m not a betting person, but I would be willing to bet that the majority would answer no to both questions. Processing contracts are complex and they are becoming much more complex every year. I can recall master agreements from 25 years ago that were only four or five pages long with single page attachments for each application processed. Today, it is not unusual for a master agreement, with attachments for all services needed (core, item, EFT, internet, mobile, bill pay and whatever else), to exceed 150 pages. These contracts are not for the faint of heart.

Before I accept an engagement, I confirm with my prospect that their expiration date will actually be in the future which will allow enough time for me to provide my services for them. Most contracts contain a 180-day notification of non-renewal in advance of the expiration date. If notice of non-renewal is not exercised by that date, the contract will renew for the specified term, effectively six months in advance of the expiration. Approximately once each year, I am contacted by an interested bank only to find out that their expiration date is just a few months away. They had forgotten to exercise their non-renewal option. Many contracts do not specify the expiration date. It is defined as X years from the first use (conversion) which may have been over a decade ago. It is entirely possible that no one working at the bank presently remembers when that conversion took place.

As part of your ongoing vendor management, make sure that your bank and your vendor are in agreement as to the expiration date. Then mark your calendar to begin action at least 18 months in advance of your expiration date. If you engage a consultant, or work directly with your vendor, do not wait until the last moment to begin this project. Waiting will limit your options.

Your outsourced processing services contract should adhere to the Federal Financial Institutions Examination Council (FFIEC) Information Technology Handbook - Outsourcing Technology Services (link below). This handbook is a great guidebook that outlines what should be included in each contract including:

Performance and service level standards.

Security and confidentiality, in particular cyber security.

Business resumption and contingency plans for when the inevitable occurs.

Sub-contracting and third party relationships that need to be clearly defined.

Costs, discounts, and price escalation which are explicitly defined. Make sure that you match contracts to proposals. I have found a few inadvertent errors in the past.

Terms of contract - all vendors are pushing for longer terms. Not too long ago, a three-year term was common. That option has virtually disappeared. Now five years is the typical term minimum, but there are longer terms available. I have mixed feelings about longer-term contracts. The financial inducement for a longer-term contract may not be in your stockholders’ best interest if there is a change of control. Longer-term contracts also decrease the ability to periodically renegotiate price which can only occur at renewal.

Termination - there are three ways to terminate a contract: 1) expiration; 2) convenience; and 3) acquisition (which isn’t so rare these days). I will discuss termination in -depth in my next blog. I have seen some remarkable situations recently and many could have been avoided.

Unfortunately, the FFIEC guide only indicates what should be included. It does not set benchmarks as to what the expected vendor responses should be. Most bankers don’t realize these issues can become as competitive as pricing. I can assist in evaluating the fine points of contracts not only in core vendor evaluations, but also for contract renewals. If you have questions regarding the technology contract for your financial institution, I would be happy to assist.

My next blog will discuss departure charges which include liquidated damages as well as deconversion charges.

FFIEC Information Technology Handbook - Outsourcing Technology Services