HG Alert: Pre-Contractual Considerations for Outsourcing Agreements - Mar 2009

The following is a reminder of four important matters for consideration by customers and suppliers prior to entering into negotiations for many types of outsourcing agreements, such as business process outsourcing and facilities management agreements.

Clear service definition

Although the service to be provided is the fundamental purpose of entering into the contract, a sufficiently detailed and clear description of the type and scope of service to be provided is often lost amongst the other, often lengthy and legalistic, components of an outsourcing agreement. This often leads to time consuming and costly disputes, and contract variation discussions with respect to what services are included in the contract price.

In agreements which are negotiated quickly, the temptation to describe the services more generally in the contract and leave the detail to be worked out operationally on a day-to-day basis can be hazardous for both the customer and supplier. Having a clear understanding, which is preferably documented, of the functional and technical requirements of the goods and services to be delivered prior to entering into detailed negotiations, can help avoid this problem later on when there is pressure to have contract negotiations completed quickly.

Service levels and service credits

Closely related to the above is the issue of the standard of service to be delivered by the supplier, and any service credits which will apply as a reduction of the purchase price in the event of a failure to meet those service standards as agreed. Consideration should also be given as to how this will be monitored and reported on by the parties, with an emphasis on finding a balance between effective contract management and performance without creating unnecessary red-tape and compliance procedures which increase costs and hamper performance.

Liability and indemnities

Risk and reward

As a general rule, the amount of risk a party adopts under a contract will generally rise or fall commensurately with the reward it receives. A supplier will wish to insist upon a higher price for adopting greater risk under the contract, whereas if a customer agrees to take on more risk (by allowing the supplier to have lower limits on liability), it will expect to be rewarded with a cheaper price. As these matters are generally the most hotly negotiated in any outsourcing arrangement, customers and suppliers would benefit from considering the following matters, in addition to the risk/reward matrix, well in advance.

A customer should carefully consider the kind and extent of any damage it may suffer if the supplier were to breach the contract. Thinking through the likely financial consequences (both direct costs and indirect costs such as lost management time) of a potential breach by the supplier, is essential prior to agreeing to and documenting any limits or exclusions on liability which a supplier requests. Bringing the type and extent of likely damage to the attention of the supplier during negotiations may also strengthen the customer’s position if it later wishes to litigate in order to attempt to recover damages for a breach by the supplier.

The supplier should think carefully about any particular types of liability it may wish to exclude, to the extent possible. For example, where software is provided for use in Australia only, it may wish to consider excluding liability for breach of a third party’s intellectual property rights which may arise by the use of that software outside of Australia by the customer in breach of the licence.

Prior to agreeing the amount of any contractual limits on liability, the supplier should liaise with its insurance advisors and brokers to consider whether adequate insurance is available. Similarly, if a customer is to agree to particular limits or exclusions, particularly those which amount to wide “hold harmless” clauses, the customer should check its insurance to ensure those clauses do not invalidate or limit its insurance policies.

Exit planning

What should occur if everything goes wrong, or simply at the end of the service period, is naturally often the last thing on the minds of the parties once a decision is made to proceed with a mutually beneficial transaction. However, having in place an effective and enforceable exit plan is essential to the customer in most outsourcing arrangements. Particularly in complex and lengthy arrangements, the supplier will at some point become the custodian of most, if not all, of the detailed and specific knowledge and assets (both physical and intangible) required providing the service to the customer. Accordingly, the customer will need a plan in place which:

  • requires the supplier to assist with the transition of the service to a new provider or to bring the service back in-house to the customer; and
  • which outlines procedures for the transfer to the customer or a new provider the assets, data, and necessary rights to intellectual property and information technology which are required to deliver the service.

If you have any queries in relation to the above, or if we can assist you in any way with your outsourcing requirements, please contact HopgoodGanim’s Technology, Intellectual Property and Outsourcing team.