The vast majority of middle-market community banks and credit unions will at some point explore acquiring or being acquired because M&As are one of the quickest and most effective ways a bank can scale up, expand reach, and grow. Unfortunately, many of these banks have no choice but to watch lucrative opportunities pass them by because they unwittingly agreed to grossly unfair and inequitable terms in their core and IT contracts.
Financial institutions constantly assess risk from nearly every conceivable perspective to protect shareholder value, but far too many realize too late that hidden astronomical M&A termination fees and other hidden contractual penalties render a deal totally unfeasible. Over and over again, blindsided banks are hobbled by stifled growth.
Simply stated, core and IT suppliers punish banks with excessive termination, de-conversion and conversion fees because they can get away with it. Suppliers also sneak in large clawbacks for discounts awarded in the past as an added pain for measure. Banks fall for it because they don’t know better.
Bank deals are complex procedures with the possibility of extraordinary payoff or extraordinary peril. Terms regarding potential M&As are buried deep within the pages of lengthy and convoluted core and IT supplier contracts. Suppliers are betting that arduous language within these five- to seven-year agreements deter bankers from looking too closely or fully comprehending terms and conditions they contain. Many banks are not thinking about a merger or acquisition when they originally signed those contracts. The suppliers’ bets pay off, and banks either lose the deal or are forced to pay in spades.
Termination fees core and IT suppliers secure for themselves in most contracts with community banks and credit unions border on unconscionable. Banks find themselves saddled with the prospect of paying 50, 80, or even 100 percent of the amount due to the core provider based on what would have been paid if the institution remained with that supplier for the life of the contract.
And these fees apply even if the financial institution they’re merging with or acquiring has the same core IT supplier. Even in cases where the core has virtually nothing to lose in the deal, they still demand a fat check for their “pains.” These fees are so high they can easily kill a potential deal before it even reaches the negotiating table — and they often do.
Banks Have Defendable Rights
A contract isn’t a contract unless there’s some cost for exiting it early. But there’s fair and then there’s fleecing — and let’s just say core and IT suppliers wield a pretty big pair of shears.
The reality is that more than half of all states will not tolerate these termination fees in court, provided they’re challenged by institutions. The maximum amount of liquidated damages a supplier is entitled to legally — provided they can rationalize how they were harmed — is the discounted value of remaining net profit. This might not be more than 18 to 22 percent of remaining contract value, or about one year on a five-year deal. That’s nowhere close to what is often claimed by core suppliers.
But you have to know your rights before you can demand they be respected, and a wealth of knowledge regarding the most favorable core and IT contract terms available can’t be acquired overnight. It’s taken many years for Paladin to amass proprietary core and IT supplier contract data.
Secure Fair Terms Now to Protect Deals Later
By updating your contracts before a transaction, you can speed the M&A process, protect your institution and shareholders, and prevent unforeseen deal risks. But you’ll need to come armed and ready for battle. Core and IT suppliers have enjoyed decades of manipulating the system to their advantage. Going it alone in your next contract negotiation will likely result in ending up with more of the same hidden and unfair terms. That’s how good these guys are at getting what they want from the community banks they call their “partners.”
There are experts with a proven track record of going toe-to-toe with core and IT suppliers and coming out ahead for community financial institutions. Time and again, we’ve approached the table with our clients, advocated for a fair deal, and walked away with terms that make sense for both parties — not just the suppliers.