An outsourcing arrangement: a quick guide to key legal issues

homePrior to undertaking an outsourcing exercise the customer should carry out a due diligence regarding the internal systems and services that will be outsourced. In particular, the customer should

  1. consider the internal costs (so as 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 their condition.

Once the customer has identified its requirements, it can issue its requests for information/pricing, on which it will base its invitation to tender to the short listed supplier. The supplier’s response to the invitation to tender together with all the information provided will then be reviewed by the customer against, technical, commercial and legal requirements and each area awarded a number which will then help to select the supplier and award the contract.

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 in relation to employees and their provision of the services to the customer during the life of the contract; (iii) liabilities in relation to 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 which are to be used by the supplier in the provision of the services may be sold, leased or loaned to the supplier. 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 life of the contract, consideration must be given as 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 for the customer. 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 which have been developed independently of the project and which the supplier may utilise for the purposes of the project. The same position is likely to arise in relation to 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 business of the customer, the losses which the customer may suffer if the supplier fails to provide the service may be significant. It is important, however, not to impose contractual liabilities that are disproportionate to the value of the contract. As a result, consideration is often given to setting limits on the supplier’s liability that relate to payments due under the outsourcing agreement (possibly on a multiple basis) or the insurable level of loss on a project-specific basis. 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 in relation to intellectual property rights or TUPE issues is often unlimited because it represents the customer’s protection for unquantifiable third party liabilities which the supplier is able to 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 management of the relationship and a clear escalation procedure where problems arise. It is important that the parties 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.

All articles are for general purposes and guidance only and do not constitute legal or professional advice.

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