Four Critical Topics Bankers Should Review in IT Contracts

Bankers of all people should know to pay close attention to the fine print.

Unfortunately, many gloss over their technology contracts, even though such services make up a big expense at financial institutions and agreements are often long and complex. Bankers can reduce headaches by examining several key areas in their technology agreements, industry experts say.

"Vendors have figured out that banks aren't really reading these contracts so they're adding more and more language that is beneficial to them," says Trent Fleming at Trent Fleming Consulting. "I don't think they're trying to steal money, but I'm confident the vendors are trying to protect themselves."

Bankers usually negotiate IT contracts every few years, putting them at a disadvantage against vendors who regularly deal with agreements, experts say. Inexperience also leads to instances where bankers overlook important details.

"Anyone can look at a contract," says Bradley Leimer, vice president of online and mobile strategy at Mechanics Bank in Richmond, Calif. "But you don't have the context to ask the right questions unless you've seen a couple hundred different versions of these" agreements.

There are several key components of IT contracts that need extra attention, industry experts say. Many of these sections include standard verbiage, though savvy bankers can negotiate more favorable terms.

Review Termination Terms

Most small banks fail to think about exit strategies when negotiating technology contracts. This oversight can have wide-reaching effects if a bank needs to get out of the contract for reasons that include a sale or switching to another vendor.

"You can't just leave a contract without some pain," says Aaron Silva, president and chief executive at Paladin. "The sneaky part is where vendors don't disclose all of the things that you need to have in your contract to protect shareholders if there is a strategic change."

Experts say acquisitions have fallen through when the buyer discovered the seller's hefty termination fees during due diligence. Early termination penalties often range from 80% to 90% of the average billing in recent months multiplied by the number of months remaining, Fleming says. He recommends restructuring this fee so it declines over the life of the contract.

Banks also need to review the language for terminating the contract for cause, says Diane Carco, president of Swingtide, an outsourcing and technology advisory firm. Contracts usually have vague language about how to end the agreement if either party fails to fulfill an obligation. It is important to push for specifics, including performance measurements for the vendor, she says.

Finally, banks must focus deconversion fees, which have "become a profit center" for vendors, Fleming says. A vendor typically agrees to provide "reasonable assistance" for a bank to switch to another firm at "current rates," Fleming says. Instead, banks should insist on a fixed cost.

Show Me the Money

There are "hundreds of places where the vendor can charge the bank scattered throughout the contract," Carco says. Swingtide requires vendors to summarize all costs and fees in a single section, making the agreement easier to review and administer.

Invoices are often incorrect, causing banks to be overcharged, creating a need for bankers to insist on extensive auditing rights, Carco says. If an error is found, the amount should be considered disputed and the bank should not be required to keep paying the amount, she says.

Cost-of-living adjustments are another area where small banks are often overcharged, Fleming says. Most vendors tie those adjustments to a specific index or 5%, whichever is greater. Banks should aim for a fixed cost. If that is impossible then banks should push for adjustments pegged at cost of living or 3%, whichever is less, Fleming adds.

Vendors are much more open to changes, even to price structuring, than banks might realize, says Leimer, who has been surprised at the number of times that a vendor is willing to make an adjustment.

"You just have to ask," Leimer adds. "It's like negotiating a salary."

We Should See Other People

Technology vendors are starting to strengthen exclusivity clauses in their contracts, which can have negative consequences for unsuspecting banks, industry experts say.

"A vendor may have an inferior banking product, so the bank wants to use a service from someone else," Silva says. "If you've got an exclusivity clause then you can't without permission."

Exclusivity clauses can bar banks from getting products and services from other vendors. The clause is so critical that Fleming says he often encourages clients to end discussions if a vendor is unwilling to strike it. Fleming says he worked with a bank that had hired a vendor for remote-deposit capture only to find out that a separate contract prevented the hiring.

Being able to look at other vendors is essential to community banks, Leimer says. In April 2010, after an extensive vetting process that involved 11 contenders, the $3.3 billion-asset Mechanics went with an Intuit platform that replaced Fiserv for much of its online and mobile banking. The bank was able to add services such as person-to-person payments and personal financial management tools.

"We continue to see smaller players that are coming from the bottom up that are able to innovate and drive digital engagement," Leimer says. "The large companies can't keep up."

Keep Their Feet to the Fire

Holding vendors accountable for exceptional service, while extremely important, is the hardest part of a contract to work out, Silva says. Banks must set expectations for service and provide a course of action if the vendor fails to meet those goals, industry experts say.

Banks should also add provisions that require vendors to supply sufficient details to verify reports on the service provided, Carco says. Contracts should have a credit structure in place that is meaningful and easy to administer, she says. These credits should serve as price adjustments for any lower quality of service received.

Additionally, banks need to leave the door open for adding future services and products as technology evolves, Carco says.

"There should be an obligation for the vendor to bring a service evolution map so you can see the changing services and you can weigh in on what's important," Carco says.