9 Key Provisions of Outsourcing Contracts That Matter

Outsourcing, whether technical or process-centric, has become an increasingly important component of businesses of all sizes. Handing over the complexity of ever-changing systems that require increasing expertise can often provide outsourcing customers the opportunity to focus on their business, drive efficiency, and control costs. But, when entering into outsourcing agreements, what provisions of the governing contract (such as a master services agreement) should both parties pay particular attention to?

In this post I attempt to identify nine. Whether it is how each parties' responsibilities are outlined or measured, how pricing operates, how disputes are resolved, data security and privacy issues, or what happens if the agreement terminates, spending time to understand these critical components at the front end of the agreement may be critical to building a relationship based on mutual benefit as opposed to animosity.

1) Service Definitions

Perhaps the most important component of any sourcing agreement is the definition of what is expected by each party. Clarity is not only the product of the significant forethought necessary for any outsourcing relationship but it also helps avoid conflict later. Consider focusing on measureable outcomes and deadlines as compared to processes and tactics. This will provide flexibility to the provider while keeping the focus on the ultimate objectives of both parties.

2) Pricing Model and Incentives

Pricing is obviously an important component of any agreement. But, more important than the direct cost is that each party is properly incentivized to make the relationship work. This requires devising a compensation regime that ensures a provider does not feel they are being held under water while nonetheless ensuring the provider has incentives for meeting objectives and sufficient penalties when well-defined performance metrics are not achieved. The complicated task is ensuring that each of the parties continually view the relationship as mutually beneficial as opposed to purely commoditized. Consider pegging compensation to specific yard markers as the relationship progresses. This allows more predictable budgets while providing flexibility to build on past successes (or missteps).

3) Data Security

Few weeks pass where there is not news of a major data breach. Often, an outsourcing provider will be a more secure option when compared to managing complex systems in-house. Nonetheless, security provisions are an important component of any sourcing agreement. Compliance with industry best practices such as ISO 27001 and ISO 27002, PCI Data Security Standard, or the Control Objectives for Information and related Technology (COBIT); breach reporting requirements; auditing and penetration testing; provisions for cyber security insurance are all terms that could be critical should a breach occur.

4) IP Ownership

Disputes often arise when it comes to untangling who owns intellectual property developed during the course of an outsourcing relationship. Whether a provider jointly assists a customer in the creation of IP or simply provides it infrastructure to develop its technology, the relationship benefits by clearly laying out who owns what when protectable IP should emerge.

5) Service Levels

Service Level Agreements (SLAs) are often an essential component of defining objective measures of performance. SLAs, however, are only as good as their definition, applicability, and scope. Spending time at the frontend of the contract ensuring that SLAs are productively defined will significantly benefit a relationship founded on trust and mutual benefit.

6) Governance and Audit Provisions

The structure of contract oversight is often a critically important component of an outsourcing relationship. Parties should seek oversight authority and transparency for the outsourcing customer but without creating oversight that is either unworkable or unnecessarily creates animosity between the parties.

7) Dispute Resolutions

How disputes are to be contractually resolved can have significant consequences for the complexity and costs associated with addressing problems that arise. For example, there may be venue and forum restrictions limiting disputes to certain states and types of courts (state or federal), or, they may require binding arbitration or informal dispute resolution. Planning for inevitable problems on the frontend can help ensure that if problems do arise, the parties can constructively address the problems without problems spiraling out of control. Consider informal dispute resolutions options as these may be more accessible to business owners and encourage a faster and more efficient resolution of problems before they escalate.

8) Bankruptcy Contingencies

The reality is that the outsourcing industry is highly competitive and the risk that potential bankruptcy could prematurely complicate a sourcing relationship is real. In order to escape any ambiguity if a provider slips into bankruptcy it is critically important that organizations negotiate terms that ensure clarity in data ownership and accessibility in case of bankruptcy. Without such terms, the bankruptcy estate may make removal of data difficult or a customer may be forced to negotiate with creditors on ownership of the data.

9) Exit

Despite the parties’ best intentions, relationships still may end. It is important that the parties clearly define what happens if it does. Provisions related to term of the contract, termination charges and transition assistance will be critically important if the relationship unexpectedly ends. Likewise, thinking about data portability obligations throughout the relationship may make a necessary transition much easier. 

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