Third-party service provider contracts-don't just accept, negotiate!

by Lisa Micciche, ABA Insurance Services, Product Manager

Using third-party service providers can increase confidence and capacity for financial institutions, but a systems breach occurring at a third-party vendor can also create havoc for any bank that hasn’t considered the risks in advance.

Regulators have stressed the importance of applying a comprehensive risk management process throughout the life cycle of the vendor relationship – from vendor selection and performance monitoring through to relationship termination.

One vendor risk management area receiving more attention lately is contract negotiations, and for good reason: Third-party providers have long shifted the bulk of liability and responsibility for their system breaches to the bank. However, banks should recognize that they have a voice in contract negotiations and look for their own contractual protections. Such protections should address:

  • Protecting bank and customer information
  • Shifting liability and expense risk of a vendor breach back to the vendor
  • Compliance with federal and state laws, such as the Gramm-Leach-Bliley Act (GLBA) and the Massachusetts Data Security Regulation
  • Compliance with regulatory guidance, such as OCC Bulletin 2013-29

Key Contractual Provisions to Consider
While there is no one-size-fits-all approach in crafting third-party contracts, here are some key contractual provisions to consider as requirements in all provider agreements:

Legal Compliance. If the third-party provider will have access to personal identifiable information, some security procedures are required by law. For example, the Gramm-Leach-Bliley Act requires service providers to adhere to the Safeguards Rule requiring organizations have a security program in place that ensures the security and confidentiality of customer records.

Security Standards. Providers should commit to adhering to an up-to-date security program that addresses physical safeguards, data and system safeguards, employee training, risk assessments and data destruction policies.

Personnel Policies. Providers should perform background checks on all employees who will have access to the bank’s data. Further, any personnel access to the bank’s data should be on a “need-to-know” basis.

Data Encryption. Encryption is a safe legal harbor in nearly all data breach notification laws; therefore, it is critical for vendors (and banks) to always transmit or store sensitive data in an encrypted format.

Response in the Event of a System Breach. A provider should be required to investigate and remediate the cause of the breach, and the bank should expect full cooperation and notification of all breach investigatory findings. The bank will want the right to control all customer-facing aspects of the breach response, including breach notifications.

Audit Access. Contracts should allow the financial institution and its regulators the right to audit the vendor’s security practices. Additionally, consider requiring third-party audits with reports copied to the bank.

Termination Rights. Maintain or obtain the right to terminate the contract if the supplier fails to comply with its security obligations. Do not tie the right to termination to an actual security breach.

Expense Reimbursement. Providers should be required to reimburse the bank for expenses incurred by the bank while responding to a breach event, such as credit monitoring services, notification expenses, and professional service fees. Vendors may push back on this and request an expense cap or require a negligence standard of liability.

Require Contractual Liability. Most vendors include contractual disclaimers of consequential damages and a general liability cap (which is surprisingly small), but banks should insist on certain exceptions to the cap, including any indemnification obligations pertaining to provider breaches of confidentiality or security procedures.


About the author

Lisa Micciche is responsible for product development and modification, as well as sales, claims, and competitive analysis for both ABA Insurance Services bank and small business program groups. Learn more about Lisa.


Source: David J. Ackley, Jr., Senior Vice President, Senior Information and Corporate Security Officer, Camden National Bank, and Joshua T. Silver, Esq., Shareholder, Bernstein Shur Sawyer & Nelson; speakers at the ABA Risk Management Forum 2015 Session, "Cyber Governance: Managing the New Risks."

This article is meant to highlight certain issues that financial institutions may wish to consider when entering into service contracts. It is not intended to be, nor is it, a substitute for legal advice. Legal contracts should always be reviewed by a company or financial institution's legal advisor or attorney prior to entering into any agreement.

Any discussion relating to policy language and/or coverage requirements is non-exhaustive and provided for informational purposes only. For details on coverage provided by your specific policy, please refer to your policy.