Outsourcing business functions can be a beneficial business strategy. As well as increasing profitability, as it can allow you to streamline your business costs in reducing overheads, outsourcing may also: 

  • provide you with access to resources that may not be available within your internal team; and
  • accelerate the scalability and transformation of your business. 

Before outsourcing and engaging a service provider, it is important to ask yourself:

  • why you are outsourcing;
  • what you are outsourcing; and 
  • who your stakeholders are. 

Your answers will help you in noting legal considerations and assess whether the benefits of outsourcing outweigh the risks. Whether you plan on outsourcing IT services or bookkeeping services, this article outlines some important considerations to help you manage your legal risk. 

Performance Guarantees 

When outsourcing, you want to make sure that your service provider: 

  • makes their services available to you as you require; and 
  • delivers their services in a timely manner to ensure your business operates smoothly. 

It is crucial that milestones and guarantees for performance are clear and accurate, because without objective criteria it can be difficult to manage the outsourcing relationship. The performance guarantees of service providers are usually set out as defined criteria in the form of:

  • Key Performance Indicators (KPIs); or 
  • a Service Level Agreement (SLA), either within or as an annexure to a formal agreement. 

Setting out KPIs or service levels in an SLA allows you to not only measure the performance of the service provider, but also hold them accountable for their services. 

When considering the performance and setting out the criteria as KPIs or service levels for your service provider, you should consider:

  • what KPIs or service levels will drive the outcome you want;
  • whether the KPIs or service levels are clearly defined;
  • whether the KPIs or service levels are measurable;
  • how often you should report performance against the KPIs or service levels;
  • how many times a service provider can fail to meet a KPI or service level before triggering a consequence; and
  • what an appropriate consequence might be. 

The specific criteria in KPIs or service levels will largely depend on the outsourced services and your negotiations with the service provider. 

For example, if you are outsourcing the management and maintenance of your internal IT systems, you should be clear about how quickly they respond to your complaints and how quickly they can resolve any issues in an SLA. 

Intellectual Property 

Intellectual property (IP) is a very valuable business asset that you should seek to protect. In the process of outsourcing services, the service provider may create new IP for your business. 

For example, if you are outsourcing IT work, an IT service provider will create IP in the software they develop for your business. The main question to keep in mind is whether you want to:

  • own the IP that they create; or
  • use the IP under a licence (which may impose certain restrictions on how you can use it). 

If you expect to own the IP the service provider creates through the outsourcing arrangement, you must include an IP assignment clause in your formal agreement. This clause will assign all of the IP that the service provider creates to your business. This allows you to own and use the IP as you please. 

Sometimes the service provider may want to retain ownership in the IP and provide you with a licence to use the IP. If this is the case, you should ensure that the licence clause in your formal agreement allows you to use the IP for your needs. If you are negotiating an IP licence with your service provider, you should consider:

  • what the licence is for;
  • whether you can modify the IP in any way;
  • Whether there are any limitations on how you can use the IP (e.g. can you only use the IP for a specific purpose? Can you only use the IP in a particular area? Can you only use the IP for a particular duration of time?); and
  • whether you can sell the IP to third parties.

Privacy and Security of Information

You may need to share data and personal or confidential information with the service provider when outsourcing services. 

For example, when providing IT services, IT service providers will likely need access to your data, personal and confidential information. 

You want to ensure that service providers: 

  • use due care and skill when handling data;
  • securely store data; and 
  • do not transfer your data without your express permission. 

The service provider may also require access to personal information your business owns which may be from your customers or your employees. You should consider whether your business and your service provider are required to comply with privacy laws. Even if you have a legal obligation to comply with privacy laws and your service provider does not, it is best to require your service provider to handle any personal information in a responsible manner and comply with privacy laws.

If your business needs to comply with privacy laws, you will also need to report eligible data breaches to the Privacy Commissioner and notify any of your customers who may have been affected. If your service provider becomes aware of a data breach, they should notify you so that you can respond and report it accordingly. This is very important if you are outsourcing IT services, as the service provider should assist you with a prompt response and contain the breach. You may also want to find out who caused the breach and you should hold your service provider responsible if it was them.

Restraint of Trade

If you are outsourcing client services, you should ensure that your service provider cannot terminate the agreement they have with you and provide the same or similar services directly to your clients. To prevent this from occurring, you should include a restraint of trade clause in your agreement with your service provider. A restraint of trade clause protects your business interests by preventing your service provider from working directly with your clients for the duration of your arrangement with them and for a certain period of time following your arrangement. 

Dispute Resolution 

The best way to reduce the risk of a dispute arising is to outline your outsourcing arrangement with the service provider in a formal agreement. Setting out the process and steps to follow in the event that something goes wrong with the service provider helps with: 

  • addressing the issue quickly;
  • preventing it from escalating; and 
  • avoiding any significant business losses. 

You can do this by ensuring the formal agreement you have in place includes a clause outlining the process to resolve a dispute. 

For example, a dispute resolution clause may require parties to first notify each other of any disputes in writing and give the other party a chance to respond. The next step may be for authorised representatives from both parties to meet and seek to resolve the matter in good faith. If that does not work, you may agree to refer the matter to mediation or arbitration. As a last resort, you could escalate the matter to the appropriate court. 

Key Takeaways

Outsourcing can be very beneficial to your business, but it involves risks. Some important legal considerations to take note of when outsourcing include: 

  • clearly setting out performance guarantees that the service provider should adhere to in the form of KIPs or service levels;
  • ensuring you can use any new IP that the service provider creates for your business needs by either assigning or licensing the IP to you;
  • protecting your data and any personal information your business owns; and 
  • having a clear dispute resolution process in place.  

If you need assistance with drafting or negotiating an outsourcing agreement with a service provider, please contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page. 

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