How to break up with a third party the right way

Ending a relationship with a third party is in many ways not unlike a personal breakup. Sometimes it ends badly, with one party walking away hurt. Sometimes it ends amicably, with no hard feelings. In both cases, all must eventually come to terms with the reality that the relationship has simply run its course.

There are things that can be done to reduce the risk of such an outcome, however. First, be honest about expectations upfront, and put those expectations in writing. Elements of a third-party contractual agreement should include, for example:

• The circumstances under which the company can execute a right-to-audit clause;
• The company’s expectations concerning anti-bribery and anti-corruption compliance with corporate policies and procedures, and laws and regulations;
• What sort of notice the third party must give for sub-contracting out work;
• The range of commissions or other types of payment that can be made to a third party without extra approvals being needed.

“All of those areas of risk should be contemplated in the contracting process,” says Bill Pollard, a partner in Deloitte’s Risk and Financial Advisory practice.

Then comes the prenuptial agreement—a contract termination clause, in business speak. The basic elements of a termination clause should stipulate the circumstances under which a termination may be warranted; how many days of notice must be provided; in what form that notice should be provided and to whom; processes and procedures for retrieving proprietary data, documents, and equipment, or for destroying and disposing of sensitive information; and a timeline for that termination. In short, it’s a means to mitigate any risks associated with terminating the relationship, should it come to that point.

As with any relationship, it’s best to start off on the right foot, not going into it thinking a breakup is inevitable. “Be mindful of what you can do to keep it a positive relationship,” says Dennis Frio, a managing director in Grant Thornton’s Financial Services Advisory practice.

Transparency is an important factor in building and keeping trust. “The more transparent the relationship is between the company and its third party, usually the more effective the relationship,” Pollard says.

“Be mindful of what you can do to keep it a positive relationship.”

Dennis Frio, Managing Director, Financial Services Advisory Practice, Grant Thornton

When that transparency starts to dissolve is when red flags can start to crop up, resulting in a potential cause for termination. Pollard cites the following red flags as examples: detailed invoices that become less detailed over time; third parties that start sub-contracting out to sub-vendors; subtle changes in terms and conditions to the contract; or requests for larger discounts.

“A third-party risk management program really should have an element of ongoing monitoring,” says Gayle Woodbury, a managing director at Crowe, an accounting, consulting, and technology firm. As part of that, relationship managers working with third parties on a day-to-day basis should be conducting periodic reviews of the third party.

Those periodic reviews should assess things like the quality, cost, and timeliness of the third party’s work, so that the company can get a clearer picture of how well that third party is performing over the course of the contract, Frio says. It’s also a good idea to monitor news feeds for any adverse media on that third party, whether there is known litigation or IP infringement cases that may serve as warning.

Finally, where more and more third parties are handling sensitive and confidential employee and customer information, it’s also important to monitor any potential data breaches.

“The key is to make sure that whomever is engaging with that third party is making sure they are actively managing the third party and paying attention to these issues,” Woodbury says. From there, the company can better assess whether this is a third party that it wants to continue doing business with, she says.

Another question the company should consider: “Is there a reputational risk to making that change? If so, how do we mitigate that risk?” says Woodbury.

Not every situation is so dire that it warrants the termination of a third-party relationship. Some trigger points are obvious, like a breach of contract, or serious concerns about the third party’s ability to perform. If the third party is involved in some type of fraudulent or corrupt behavior or has been named in a government investigation, the likelihood of the company continuing to use them diminishes significantly, Pollard says.

Another obvious trigger point is breach of a confidentiality clause. Some companies stipulate in their contracts that a breach in confidentiality will result not only in termination of the relationship, but further requires the third party to pay back any punitive damages in some cases, Frio says.

Outside of certain egregious situations, the real struggle over whether to terminate a third-party relationship concerns behavior in the gray—for example, a third party that isn’t necessarily in breach of a contract but is being delinquent about its compliance obligations.

The decision becomes even harder when you have the sales and operations teams pressuring others in the company to maintain the relationship if that third party is integral to the company’s bottom-line success. Faced with such pressure, it helps to have full visibility into the third party from all business units, including compliance, legal, finance, sales, and marketing. “If the company doesn’t connect the dots across the organization about a third party, that’s when it’s hard to figure out where to draw the line,” Pollard says.

Providing notice

“You’d want to make sure you have your ducks in a row well in advance of providing notice,” Woodbury says. As part of that, all parties involved in dealings with that third party should be notified, including the relationship owners themselves, other business units, business partners, and customers of that third party.

Just be careful not to forget to provide notice to the third party with whom you’re ending the relationship. There have been situations where companies have gone through the whole internal process of preparing to terminate a third party but forget to inform the third party itself. “As silly as that sounds, that happens,” Woodbury says.

Another common mistake companies make is to provide a termination notice to a third party, only to realize that they’ve underestimated the time and effort it takes to onboard a replacement third party. “You’ll want to work through your transition plan and have a good estimate on what that’s going to take before you provide notice,” Woodbury says.

Once you’ve provided notice, the next step should be following through with an exit strategy to ensure that activities are transitioned without disruption. An exit strategy should consider things like whether you’re going to bring the services in-house, transfer them to another third party, or discontinue them altogether. If you bring it in-house, you’ll also need to ensure you have the right skillsets and resources in place or figure out how long it will take to put those skillsets and resources in place.

Alternatively, if you’re switching third parties, it’s always good if you can identify in advance who your alternate third parties would be; how much time will be needed to make that transition; and what steps are necessary to onboard that new third party.

It’s also important to ensure that you’ve cut off access to any assets or data that you’ve provided the third party and, furthermore, that you have a plan in place to safely and securely transfer that data either internally or to the new third party. If you have any outstanding invoices, you’ll want to make sure those are all paid off as well.

The company should continue with ongoing monitoring of the third party, keeping in mind that claims can still arise with a third party even after the contract has ended. “Certainly, in the financial services industry, we have seen enforcement actions where that type of situation has happened and the regulators have held banks accountable,” Woodbury says.