Credit unions are under pressure by their members to provide a variety of financial services. Credit unions are also under pressure to deliver operational services more efficiently and effectively. The solution to these pressures often involves selecting third party service providers to deliver the services the credit union either cannot provide or provide as efficiently itself.

A credit union may have dozens of relationships with service providers. The job of selecting service providers, negotiating the terms of the agreements and monitoring the relationship is often left as the part-time duties of various staff in the credit union (e.g., the loan department for lending services, the IT department for IT services). It is right and appropriate for the subject matter experts in the credit union to participate in the decision making process regarding service providers, but who in the credit union is responsible to supervise the key relationship issues for service providers? Who at the credit union works with the service provider when there is no subject matter expertise at the credit union (e.g., investment, insurance and trust services)? There are policy, contract and management issues that should be consistently addressed in order to protect the credit union’s primary interests no matter what the service.

Too often the credit union enters into an agreement with a service provider that is incomplete. The agreement may be the service provider’s proposal or template which may not be appropriate in every instance. Key contractual elements, particularly those protecting the credit union, are often missing. Further, there may be little to no follow up on the management of the service provider relationship. This lack of attention by the credit union to contractual details often results in situations where the credit union is caught off guard and embarrassed by an unforeseen incident involving a service provider or where the credit union cannot take the action it desires due to a deficiency in the terms of the contract with the service provider.

I, therefore, strongly recommend that each credit union adopt a Service Provider Policy to both enhance the value of the relationships and to protect the interests of the credit union. I discuss below the suggested content of such a Policy.

Service Provider Policy

I recommend that the Policy establish the following:

1. Statement of Philosophy in Service Provider Relationships

The philosophy statement will help guide the credit union staff in the implementation of the Policy. I recommend that the statement contain the following:

a. Positive relationships with service providers are critical to the success of the credit union.
b. The staff of the credit union shall be informed and educated about our service providers and their respective role in the credit union’s success in its service provider relationships.
c. The staff will be expected to fully cooperate and contribute their part to the success of the service provider relationships and be held accountable for their respective duties.
d. The credit union staff will perform their legal and business due diligence to insure that the credit union has an effective business model for a particular service.
e. The credit union will have a Service Provider Administrator (“SPA”) appointed by the President to implement this Policy. The SPA has the authority to counsel any service provider or staff regarding their conduct in a service provider relationship. The SPA shall be involved in the service provider selection process, contract negotiation, the implementation process and the monitoring process. The SPA shall report to the senior management as the President directs.

2. Service Provider Selection Criteria

How does a credit union find service provider candidates? The key is knowledge. Many credit unions seeking a service do not have the knowledge of where to begin to identify service provider candidates. One of the key functions of an SPA will be to network with industry colleagues to gain a knowledge base for the credit union to draw upon for options to meet its service needs. If this is someone’s dedicated job, think how much easier it will be for senior management to select a service provider who will best serve the needs of the credit union. They do not have to be the pathfinders for every new service.

Next, how does a credit union select the right service provider from the candidates? There is no one right way for every situation. Some credit unions go through a formal request for proposal process. Key decision factors are asked in writing, and the candidates provide a written response. The first cut is made. The remaining candidates are interviewed, and a final selection is made. I have some recommended guidelines in the selection process.

a. Do not put the credit union or the service providers through a request for proposal selection procedure unless it is necessary in order for the credit union to make a decision. The process is time consuming for all concerned and is unfair to a service provider candidate whom the credit union knows has no real chance of being selected.

b. Always check references from outside or other credit union clients who the service provider currently serves and no longer serves.

c. If the service provider will be providing a critical service, perform a due diligence visit to the service provider’s place of business and meet their staff.

d. Be specific as to the credit union’s expectations and communicate the expectations to the candidates. The credit union should not go into a selection process not knowing what it expects from the relationship. It is unfair to the service provider and ineffective for the credit union.

e. Do not let the process linger. Meet the timelines and make a decision.

3. Critical Contract Terms

I recommend that the following contract terms be considered and inserted as appropriate in service provider agreements:

a. Clear Definition of Duties of the Parties
The agreement should be very clear on the respective duties of the parties. Be sure to answer the following questions. Who has responsibility to do what task and when? What is expected of the service provider? What is expected of the credit union? Input from subject matter experts is also critical. This expertise may be from credit union employees or consultants.

b. Acceptable Risk Allocation
It is important that the credit union and the service provider fairly allocate the risks. Risks should be allocated to the party who is responsible to perform the action which creates a potential risk. Each party should indemnify the other for its actions or omissions that cause liability to the other. The indemnifications should include reasonable costs and attorneys fees. In most circumstances, liability insurance should be required to be obtained by the “active” party (usually the service provider) with proof of insurance provided to the other party. Mutual warranties should also be given that are reasonable and consistent with the risk allocation.

c. Ability to Terminate the Agreement at Any Time without Cause and Cost
Many issues can be resolved by the ability of either party to terminate the agreement at any time without cause. Reasonable notice should be given. The notice periods most often used are thirty, sixty or ninety days. Some services such as core processing systems will require a greater notice period. When determining the appropriate time frame for term, consider the possibility of the service provider terminating the contract and the time from within which the credit union can realistically replace such service provider. Beware of agreements that require a credit union to pay a termination fee or reimburse the service provider for its internal costs in the termination process. Some service providers will argue that they are just recapturing their start-up costs. The counter reply to this rationale would be that all parties have start-up costs and this is a cost of doing business. If the service provider performs well, there will be no reason for the credit union to terminate the agreement. It is wise to consider the credit union’s cost of entering into this relationship; an ability to terminate is not necessarily the solution to other unacceptable terms of the contract.

d. Fair and Fully Disclosed Revenue Sharing
The credit union should network to find out what is a fair revenue share for the type of services being provided. Both parties need to be fairly compensated. Beware of service providers who do not fully disclose where every dollar of revenue is going. Credit unions should have a very clear picture of who is involved in the model and how much each person or entity is earning. Such information will enable the credit union to better understand the fairness of the revenue sharing and who is involved and incented in the service process.

e. Control of Member Relationship
Most financial products are commodities. The core differential for credit unions is the trust within the member relationship. Credit unions should zealously guard the relationship with its members. During the agreement term, the service provider should agree not to disclose member information for any purpose other than the performance of its duties under the agreement and not to solicit members for any product or service, other than the agreed service. On termination of the agreement, the service provider should agree to cooperate in the transfer of member accounts to the credit union’s new service provider and agree not to solicit the members post termination. Members can always choose to go with the service provider, but their choice should not be based on solicitation by the service provider.

f. Privacy
It is critical that the credit union consult with legal counsel to insure that the information sharing terms are permissible. The privacy terms should require that each party:

(1) Agrees to comply with privacy laws;
(2) Agrees to protect the other party’s confidential information to the same degree as it protects its own confidential information with appropriate polices and procedures;
(3) Gives the other party and their regulators the right to inspect its polices and procedures; and
(4) Will notify the other in the event confidential information is compromised and the one responsible for the compromise will indemnify the other for the costs of remedying the problem.

g. Performance Standards
It is very helpful to have agreed upon performance standards so that the parties have a mutually understood objective base to judge performance. The performance standards often use member survey results as one means of measurement. Performance standards help credit unions monitor and prevent negative events from adversely affecting the member relationship.

h. Management Reports
It is difficult for the credit union to assess performance without management reports. The service provider should agree to provide the credit union with management reports. Service providers and the credit union should agree as to the content and frequency of such reports.

i. Ownership of Branding and Goodwill
Each party should protect its brand and/or good will. The parties should agree to respect the value of the other’s reputation in the marketplace. Each party should have the right to review any market or promotional material using its name, trademark, or other intellectual property. The same should not be used without the owner’s consent.

j. Ownership of Intellectual Property
To the extent that each party has or develops certain intellectual property during the term of the agreement (marketing pieces), that property should be protected and proprietary.

k. Dispute Settlement
Each party likes to have disputes settled in their home town using the law of their state. This is a negotiated item. The use of mediation and arbitration is often included. Note that if mediation and/or arbitration are used, each party should always reserve the right to obtain injunctive action by a court, especially regarding unauthorized solicitations and breaches of the privacy provisions.

l. Assignment
Typically, the agreement should not be assignable without the consent of the other party. Sometimes assignments between the credit union and its CUSO are permitted without consent.

4. Relationship Management Duties

The SPA should make sure the credit union is receiving the management reports from the service provider as agreed. The SPA should meet with the service provider as the need arises and at least once a year to review the relationship and what steps can be taken to improve the relationship. The use of performance standards and relationship monitoring are great tools for the credit union management to access the success of a service provider relationship. A much greater comfort level for these relationships will evolve which will be more satisfying to both the credit union and service provider.

The improvement of the relationship could mean that the service provider has to make changes, but it also means that the SPA may have to run interference for the service provider at the credit union. The lack of knowledge of the credit union staff or the resistance to change by the credit union staff often kills a service provider relationship. The SPA can contribute greatly to a successful relationship by enhancing the service provider