Two years ago, I was asked to review data processing contracts for a small bank to determine departure costs as part of a potential acquisition. We have a very active Investment Banking Division that provides assistance to banks looking to acquire and banks looking to be acquired. In either case from time-to-time, I am asked to provide estimates for terminating processing contracts and deconversion charges. I would like to share with you two recent examples regarding terminating processing contracts.
Our client was considering acquiring a bank that had just extended its outsourced processing contract for five years and the contract had been signed the previous year. I estimated that 36 months would be remaining in the contract term at the time the acquisition would close. The processing agreement indicated that liquidated damages would be at 100% of remaining charges. However, there was a catch. The calculation would be based on the invoice less discounts. There was a monthly discount on the invoice (not apparent in the contract) for over $9,000. The net invoice was for $25,000. However, the termination fee would be based on $34,000 for 36 months. Termination fees added up to a whopping $1,224,000 based on the non-discounted invoice (as opposed to $900,000 for the net invoice) — 36% more than the bank would have paid for the services had it fulfilled its contract!
It is actually worse than that - as I do not agree that the termination fees should ever be at 100% of remaining value regardless of how it is calculated. Does your vendor enjoy 100% profit on the services provided? Of course not! Then why should they be entitled to that when the contract is liquidated? Unfortunately, that was what the bank and the vendor agreed to in the contract. Contract termination is not the time for negotiation!
Deconversion fees can also become exceptionally expensive if not controlled in the contract. Too often I see contract terms for deconversion services “at the then current fee schedule.” Which is what exactly? There is no protection in that provision for the bank. It allows the vendor to charge whatever it wishes to charge.
I recently spoke to a bank that had completed an acquisition of a much smaller institution the year before. The deconversion fees charged were three times the acquired bank’s annual processing expense. Due to these exceptional charges, the acquiring bank was adamant they would never consider the acquired bank’s vendor as a core processing provider in the future. Who could blame them? Acquired banks may no longer exist, but management teams on either side of the acquisition who are familiar with the details will always remember excessive charges.
The examples I cite above may be extreme, however, I am sure that many banks have made the same costly mistakes. In the cases above, the banks’ stockholders bore the brunt of improperly negotiated contracts (more likely not negotiated at all). In my opinion, both scenarios are overreaches by the vendors.
Contract termination fees affect the purchase price in acquisitions. Deconversion fees affect any bank that changes core processing systems whether through acquisition or at contract termination.
If your bank has signed a standard boiler plate agreement from your vendor, that contract most likely contains damaging provisions that will cost your bank hundreds of thousands of dollars. You could be charged exorbitant fees if your bank terminates services with your vendor for any reason.
There are other important core processing contract provisions that need to be closely scrutinized and skillfully negotiated in addition to the examples above. I called these examples out because I frequently see outrageous provisions that never should have been approved.
I suggest you review your technology contracts now. It is never too early to begin planning for the next contract to achieve more beneficial terms. If I can answer questions, help you navigate contracts, or prepare you for an M&A deal, please contact me.