The Legal Considerations of Outsourcing
This article discusses the legal implications of outsourcing. It also details the legal aspects to consider when drawing up outsourcing contracts such as KPIs, liabilities and dispute resolution.
Outsourcing has become a lucrative business model over the last few decades. It provides businesses and organisations of various sizes with several benefits. Many companies pursue outsourcing to access resources they might lack in a quickly and economic manner. Outsourcing also helps businesses to grow without having to invest more into infrastructure, technology or office space.
The global outsourcing industry continues to grow at unparalleled rates, with an expected growth of 7.9% in 2021. The global outsourcing market was estimated to be $92.5 billion in 2019. The US leads the market generally, as is evident through the fact that a staggering 84.2% of outsourcing deals were generated in the US in 2017. However, the sector is becoming more attractive in other parts of the world. In the APAC region, Australia, followed by Japan, had the highest outsourcing spending recorded.
Outsourcing and Covid-19
The Outsourcing sector is expected to continue its growth trajectory in the coming decades. There are speculations that the pandemic may have further spurred the growth of the industry. Work-from-home setups have proved the feasibility and viability of remote jobs and reinforced the case for outsourcing across various business functions.
Businesses have traditionally sought to outsource certain functions or jobs such as support call centres, debt collection, IT, inventory management, to name a few, but there are also other areas that businesses today would consider outsourcing.
Outsourcing disputes can arise due to poorly written contracts or due to breach of contracts. The BSkyB vs HP Enterprise Services UK case was one outsourcing dispute that became a huge litigation battle. BSkyB took HP Enterprise Services to court on claims of fraud, negligence and breach of contract. HP Enterprise Services had agreed to service obligations that seemed impossible to meet within the agreed-upon milestones. When the contract terms were not met and services were not performed as expected, BSkyB took the matter to court.
Despite a capped liability of ₤30 million, the company walked away with ₤200m in damages. Such disputes warrant the need for a carefully constructed contract that can ensure obligations are met, and the chances of disputes are minimised.
Legal Aspects to Consider When Outsourcing
As outsourcing continues to grow, businesses are becoming more open to adopting it. While there are business aspects to consider, outsourcing decisions also involve several legal implications. Knowing these beforehand can help you draft a viable and legally safe contract for you and your business. Here are some aspects you should consider when you embark on an outsourcing arrangement.
1. Terms of Agreement
This refers to any negotiations regarding the contract period, such as how long the vendor will provide the services and what the terms and conditions for renewal will be. Outsourcing agreements are rarely made for very long periods. On average, outsourcing contracts operate for anywhere between 6 months to 5 years. But there are situations where agreements can go for more extended periods, and this must be provided for in the terms of the agreement.
2. Provision and Performance of Services
When choosing to outsource a function, the business will have certain expectations regarding what services they expect, and the standard of performance is expected when executing those services. All relevant terms will have to be specified and agreed upon by both parties. When negotiating the terms, consider the following:
- Tasks and responsibilities to be undertaken
- Timelines of the obligations that need to be met
- Any contingencies in place to accommodate uncertainty or any unforeseen situation
- Provisions for any changes to the obligations in terms of workload, revised deadlines or any other adjustments required
- Performance measures and key performance indicators (KPIs) – what they are, monitoring and tracking details (when to report and review)
- Provisions for when the vendor is unable to deliver said tasks and KPIs.
The final agreement that is signed by both parties should be as detailed as possible, covering all potential aspects of the outsourced function.
3. Liability Clauses
Liability clauses outline the legal grounds when losses are incurred, in other words, who bears the responsibility of potential losses. If the losses are due to the supplier and have substantially impacted the business, the supplier may assume liability. It is essential to negotiate the limits of the losses either party will bear. The caps need to be proportional to the damage caused and cannot be irrational.
Some situations may not have a cap, such as when the issue concerns intellectual property rights or leaks of confidential information. The liabilities and compensation for these should be considered accordingly.
4. Use of Assets
In some cases, businesses may extend the use of their assets – office space, infrastructure (physical and technological) and networks to the vendor. There needs to be a legal agreement on what assets the vendor has access to in such cases. It is also important to identify what the assets can be used for and when. The period for which the assets can be used may differ from the duration of the contract itself.
5. Intellectual Property Rights
While negotiating the use of assets is critical, addressing the intellectual property clauses is even more crucial and requires great diligence. The first step should be to identify the ownership of IP both parties hold and what IP assets will be shared. The agreement also needs to detail what the assets can and cannot be used for and the implications of any transgression of rights.
If any intellectual property is created whilst the contract is being carried out, there must be clauses pertaining to such assets. Will these assets have shared ownership or not? Are they to be licensed for the duration of the contract? And who will take over the IP at the time of termination?
Also, consider whether and which of the IP assets can be shared with third parties. All clauses need to be part of the agreement when the outsourcing contract is signed.
6. Information Security and Data Privacy
When you contract an outsourcing vendor, they will have access to your business’ information. Depending on the function being outsourced, certain data and information will be shared with the vendor.
There needs to be an agreement about:
- What will data be shared?
- What will the data be used for?
- Who can access the data?
- Measures of privacy and data protection.
- Protocols in place to manage data leaks and any occurrences of infringement.
The business will also be required to comply with set protocols in order to contain any breaches and set precautionary measures in place. These include informing the relevant authorities of the extent of the breach and the individuals whose information may be compromised. These measures vary according to the industry. For example, financial institutions outsourcing cloud solutions need to abide by guidelines issued by the Australian Prudential Regulation Authority (APRA).
7. Dispute Resolution and Jurisdiction
The contract should always include methods of dispute resolution that will be relied upon in the case of conflicts or breach of contract. If the function is outsourced to an entity in a foreign country, the legal implications will differ. It will have to be specified which country’s laws will be followed and what jurisdiction will be adhered to when resolving disputes.
Dispute resolution procedures include litigation, arbitration, mediation and negotiation. These can be used in cases of breach of contracts, fraud or negligence by either party.
8. Termination Clause
As important as performance clauses are, are termination clause is equally as important for outsourcing contracts. This clause determines when the services contract will be terminated. It also determines what obligations are to be met by both parties at the end. The transfer of assets, data and IP assets needs to be agreed upon.
Termination of contract may also be applied in case of inability to fulfil obligations, data breaches, financial distress, or unforeseen situations. This ensures a smooth and fair termination for both the customer and vendor.
As a business considering outsourcing, make sure you have covered the following when contracting with the vendor:
- Define obligations, delivery timelines and milestones and set remedial procedures
- Include and consider data and privacy clauses and the use of any physical assets or IP
- Define the jurisdiction and dispute resolution techniques in case of any conflicts
- Determine termination clauses for a smooth end to the contract
It is absolutely critical to draft a air-tight outsourcing agreement regardless of who your vendor is. If your outsourcing contracts are poorly drafted, you may be risking your future business endeavours and longevity. At Lazarus Legal, we have a team of business lawyers that can assist you with any outsourcing agreement requirements. Get in touch, and we will be glad to assist you.