IBM's possible takeover of Sun Microsoystems is progressing slowly, but in an economy where vendor mergers are commonplace, end users need to understand the contract and legal implications of the changing landscape.
Diana McKenzie, head of the information technology practice at Chicago law firm Neal, Gerber & Eisenberg LLP, has specialised in IT contract law since 1987. She spoke with Computerworld about what customers of IBM and Sun Microsystems Inc. need to know about contract law as IBM pursues its reported $6.5 billion bid to acquire Sun.
If a company has contracts with both IBM and Sun, and the contracts have different terms, which one applies if the acquisition happens?
That, to me, is one of the more interesting things about this merger. If you buy another server, and you've got a Sun contract in place and an IBM contract in place, there needs to be a healthy discussion when you're doing an amendment about which contract you're amending. The customer may have a very different idea than IBM has as to which contract should apply.
Typically what happens is they create an entirely different contract in order to handle the amendments. If I have a contract with Sun, and Sun is acquired by IBM, then IBM is responsible for everything Sun was responsible for - with some exceptions -- under the contract. So if Sun promised me that for my $1 million per month I would get John Smith to appear on my doorstep every Friday at five o'clock to answer any questions, then John has to continue to do that.
How are the negotiating styles of IBM and Sun different?
There are very, very different types of contracts that the two companies have put forward. Sun has changed dramatically - Sun contracts used to be one of the tightest in the industry. So if somebody's got a really old Sun contract - and I'm talking vintage mid- to late-'80s, when Sun was basically the only player of its type in the marketplace, and there was really no competition - those contracts bordered on contracts of adhesion. They were so strict, so favorable towards Sun, that some lawyers would argue that they may not even be enforceable, they were so draconian.
In 2009, Sun has a very different kind of contract, and they have typically been more accommodating on their terms. IBM is somewhere in the middle - they tend to be fairly conservative in their contracting, but in their larger, strategic deals, they are willing to do some negotiation.
What sorts of personnel provisions can companies include in amending their contracts to ensure they continue to have access to the people they know?
We typically put those provisions in for any key personnel - it could be a service manager, or it could just be a person who creates interfaces, but you've got a lot of interfaces being created. It's anybody who's critical to your enterprise.
They're not going to guarantee they won't lay somebody off, but you can make it more painful for them to do so. You can demand, and most vendors will agree to this, that you get the first 80 hours of the new person's time for free if it's on a T&M [time and materials] basis. If it's not on a T&M basis, you figure out some kind of financial equivalent of that.
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If I'm a Sun customer and I like their stuff, is it safe to stick with them? Is now a good time to deal?
Sun is highly incented, because typically [in negotiations with an acquiring company] there's something in there about contracts and profits and whether they're closed or not. So you may be able to negotiate an even better deal because of this merger since, at the risk of sounding very crass, the executives have an incentive to get the deal done before the merger occurs. There's money in it for them, to be blunt, so they may be less concerned about terms than they would otherwise be. They're not going to be ridiculous, but there may be more elasticity in some of the terms and on price.
So now would be a really good time to negotiate a deal with Sun?
IBM is reportedly poring over Sun's contracts as part of its due diligence effort. What sort of things is it looking for?
An example would be that there are sometimes terms in contracts that say you can't assign a contract to anyone else; sometimes they say you can assign them to certain companies but not to others. They're going to look for those types of clauses to see if what they think they're buying is what they're actually buying.
So a customer could have a Sun contract with a clause that stipulates that it can't be assigned to IBM?
Could be. What happens -- and we've written these types of contracts before, although not necessarily for these particular vendors -- is a customer may have had such a bad experience with a particular vendor that they'll request that the contract with their new vendor provide that they're not allowed to assign anything to the vendor they don't like anymore.
What would happen from a practical perspective is that IBM, since they're the acquirer here, will say, "OK, when we value what we're going to give you per share, we're not doing to include the value we ascribe to these particular [customers] because these contracts aren't movable." What then happens is Sun would go back to their customers and say, "You sure? Don't you think IBM would really be great after all?"
Sometimes what happens is the customer will say, 'No, we weren't kidding then and we haven't changed our mind.' And some will say, "Oh, that was somebody else, and we don't feel that way anymore." And the smarter ones will say, "Yeah, what's in it for us? We'll take that out of the contract, but you have to give us something in return."
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I know that in the '90s, it wasn't uncommon for companies to have a stipulation in their vendor contracts that protected them if the vendor was acquired by what was then Computer Associates, now CA. It seems this is a practice that goes well beyond CA.
CA was the poster child for why those provisions originally got written. They got written because CA took a very aggressive stand with its customers - sort of unprecedented, really. There were a lot of companies that had gone way over budget because CA had figured out some trick in their contract to extract more money. And many a CIO lost a job or lost a bonus as a result of some of their antics. I do recall seeing a lot of contracts that allowed the company to immediately terminate the contract without termination fees if CA were to acquire them. That's typically what you'll see.
I have seen provisions in contracts that listed both IBM and Sun [as cause for voiding a contract in the event of an acquisition by either company]. But neither are as common as CA was. CA was the universally hated vendor in the late '90s. They were always up to some sort of mischief. IBM and Sun just don't have that kind of mentality. But that's not to say that there aren't CIOs that have had bad experiences with either of those and have put them in, because I've written them in.
Of course, it's not just IBM and Sun -- it's any number of vendors. I don't want to imply, by any means, that they have a monopoly on this, because that couldn't be further from the truth. Over time, nearly every vendor gets written in. And most of the time vendors don't even know that they're written up in some other vendor's contracts. They know they've lost the deal, but they don't realise just how unhappy the customer is, and how adamant the customer is that they never, ever want to go back to that company again.
Some CIOs I talk to say they're taking advantage of the fact that vendors are hurting because of the recession, and they're trying to renegotiate their contracts. Are you seeing a lot of that?
We are just starting to see a swelling of that emerging. I have to tell you, the ones who are doing it are really, really smart. I've been practicing for decades, and now, contracts are really unbelievable by any standard. We're getting provisions in contracts that two years ago I would have told the client, "You're never going to get that, don't even bother asking." I'm seeing contracts that historically would have taken three months to negotiate being sent to the vendor and signed the next day.
So the folks that are on to the idea of "Let's try to make some money here and renegotiate the contract" have the right line of thinking. What they're going to have to do for that is extend the term, because the vendors aren't stupid. But if you know you want to stay with the vendor for a longer period of time, this might be a great time to say, "Hey, our contract expires in 2011, but we'll extend it to 2015 if we can have these terms." You'd be amazed - we have clients just starting to do that now and are being delighted with the results, both from a cost standpoint as well as a terms standpoint.
What sort of things are you seeing now that you would never have seen two years ago?
Some of the discount provisions, particularly the discounts on future products - you're just seeing literally multiples of what you've seen in the past. Getting a warranty for a requirement like scalability could be difficult. Not so difficult right now.
So if you've got response time or availability or compatibility or any other commonly-requested requirement, a few years ago when the economy was going great, you would spend days negotiating just what you mean by compatibility, what's included, what's excluded - you'd spend an inordinate amount of time on it. Now, you can make very broad statements and they just sign them because they want the deal done, they want the money.
If the stock market going up today is any indication, those terms aren't going to be available forever. But the companies that are smart and are renegotiating now are getting some tremendous deals.
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