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An outsourcing arrangement: a quick guide to key legal issues

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Do you know what can go wrong with outsourcing parts of your business?

A lack of knowledge of the internal costs of operating the services versus outsourcing is one area that business owners can get wrong.

Plus, what are the legal, tax and commercial considerations to outsourcing a service your customers currently get from you? Right now, you will have more questions than answers so give yourself plenty of time to do the due diligence so you have the answers needed to proceed to provider selection with your RFI (request for information) and RFP (request for proposal), also known as RFT (request for tender).

To understand if outsourcing is a viable option:

  1. consider the internal costs (to ensure that the new outsourced service is competitive),
  2. review all legal, tax and commercial issues, including third party contracts (software licences, maintenance agreements, leases, and supply contracts)
  3. any assets (including employees) needed to provide the services, including the value of those assets, ownership rights, and condition.

Getting to the invitation to tender or RFP is the main milestone for change. First, you’ll need to assess the RFPs on the technical, commercial and legal requirements.

Contract Negotiation

Once the supplier is selected (or sometimes even before), the contract negotiation will start. The contract will address the following key issues:

Term

The length of the outsourcing agreement will need to be considered, including the length of the period for which the customer may reasonably predict its needs for the future, the potential life expectancy of any assets used to provide the services, the pace of perceived technological change and the financial implications of the length of the outsourcing agreement.

People issues

The people issues surrounding an outsourcing arrangement are complex, including (i) transfer of the employees; (ii) ongoing obligations concerning employees and their provision of the services to the customer during the life of the contract; (iii) liabilities about employees involved in the provision of the services at the end of the contract term.

Assets and third party contracts

Assets owned by the customer to be used by the supplier in the provision of the services may be sold, leased or loaned to the supplier. Therefore, the outsourcing agreement will need to address what happens to the assets at the commencement of the arrangements, the treatment of assets (including new assets which are used by the supplier for the sole purpose of providing the services) during the life of the outsourcing agreement and what happens to the assets at the end of the contract term.

Intellectual property rights

During the contract’s life, consideration must be given to how any new intellectual property rights are to be dealt with and who will own them. Much of this will depend on negotiation, the price paid for the services and the extent to which the services provide a bespoke solution.

If the supplier assigns the intellectual property rights to the customer, the customer will need to grant the supplier a licence to use such rights in the performance of the services.

However, the supplier will normally retain the ownership of any intellectual property in its proprietary products developed independently of the project and which the supplier may utilise for the purposes of the project. The same position is likely to arise concerning any third-party software. In such circumstances, the relevant intellectual property right will usually be licensed to the customer.

Liability issues

Where services are critical to the operation of the customer’s business, the losses which the customer may suffer if the supplier fails to provide the service may be significant. However, it is important not to impose contractual liabilities disproportionate to the value of the contract.

As a result, consideration is often given to setting limits on the supplier’s liability related to payments due under the outsourcing agreement (possibly on a multiple basis) or the insurable level of loss on a project-specific basis.

 

However, it is also important to identify any areas where the supplier’s liability should not be subject to a cap.

For example, the supplier’s indemnity with intellectual property rights or TUPE issues is often unlimited because it represents the customer’s protection for unquantifiable third party liabilities, which the supplier can prevent or control.

Service levels

The service description should be drafted as a legally enforceable document using consistent terminology, with a detailed description of the services, the obligations of the supplier clearly identified and what the supplier is to provide and what the customer expects to receive and a set of service levels (sometimes referred to as key performance indicators).

Contract management, Termination and Exit issues

The outsourcing agreement will need to include a mechanism for managing the relationship and a clear escalation procedure where problems arise. The parties must agree in the outsourcing contract a process of escalating remedies if problems arise, which supplement the agreed delay deduction and service credit regimes with the possibility to mediate if the internal escalation is unsuccessful.

Finally, the exit plan should address

  1. the continuation of provision of the services for the duration of the notice period and any run-off period, including potential co-operation with the new outsourcer or customer (in case of in-sourcing),
  2. the return or transfer back of assets and software (if required) and necessary assignments/licences of intellectual property and the provision of information and know-how to the customer or a new supplier and
  3. the treatment of employees and any obligations to inform or consult under TUPE and other relevant regulations.


Please note we are not legal experts, and all our articles are general information and do not constitute legal or professional advice.

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