Legal detail is crucial and shouldn’t spoil partnership

An outsourcing arrangement which lacks legal finesse is doomed to end in tears, as Jonathan Ames discovers


From the chap cleaning the office floors to the dinner lady in the canteen, from the geek who wanders round rebooting desktop computers to the scientist carrying out complex pharmaceutical clinical trials – just about every aspect of modern business can be outsourced.

Long gone are the days when everyone was a “company man”, employed by one monolithic corporation. The benefits of outsourcing are touted as appealing directly to boardroom bottom lines – it takes non-core business functions off the books, removing responsibility for boring issues around personnel, payroll, facilities and technology, leaving executives to get on with what they do best.

But there are legal traps waiting to snare those businesses that charge in unadvised to embrace outsourcers. So while outsourcing has the potential to benefit a company’s profits, watertight contracts are crucial to cover a range of areas, including service levels, data protection, compliance, security, and break and financial penalty clauses.

Specialist lawyers point out that every area a business might wish to outsource comes with its own peculiarities. But before looking at the nuts and bolts of contracts, businesses need to address core issues around employment and the impact of European legislation.

The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) is the UK’s implementation of the EU 2001 Business Transfers Directive. TUPE has two significant ramifications on outsourcing. First, staff currently employed by a business wishing to outsource their tasks have a right to transfer with their roles to the new provider.

“The big issue is who picks up the risk and the cost of those employees,” says Mark Prinsley, an outsourcing partner in law firm Mayer Brown. “Because often the new employer won’t want to take on all the former employer’s staff.”

Likewise, on termination of an outsourcing agreement, the supplier’s staff assigned to the function also fall under TUPE provisions, meaning the customer or a successor service outsourcer could be forced to have them transferred back.

Just as engaged couples might find drafting a pre-nuptial agreement useful, despite it slightly dulling the romance, businesses should discuss potential future difficulties with outsourcers before tying the knot

Once businesses have understood the employment issues around outsourcing, there is a raft of points lawyers argue must be incorporated into any contract. To determine which are most important, businesses need to be absolutely clear about what functions they want to outsource.

“Can you put a rope around it?” asks Mark O’Conor, a partner in law firm DLA Piper’s technology group. “And then what is the target operating model; in other words, what is the desired end-state? Clear definitions of what the business wants and how the outsourcer is going to provide it must be written into the contract. If it is too vague and amorphous, and not sufficiently precise, then the outsourcer will be unlikely to do cheaper what the business is already doing in-house.”

After defining the functions, key contractual elements should cover performance levels, payment mechanisms and remedies if it all goes the shape of a pear. Indeed, that last point, say lawyers, is arguably the most crucial.

Just as engaged couples might find drafting a pre-nuptial agreement useful, despite it slightly dulling the romance, businesses should discuss potential future difficulties with outsourcers before tying the knot. “We try to ensure that a client business is not drafting a contract where the only remedy is termination,” says Simon Colvin, an IT partner in law firm Pinsent Masons.

“We include escalating remedies – greater transparency of reporting to higher levels at both businesses – so the partnering arrangement between customer and supplier can be maintained, rather than it being a battle with arms drawn. In our contracts, termination is the last resort.”

Short of termination, contracts can include provisions for the business to take aspects of the service back from the outsource supplier. Or the ability to require the contractor to pull back on-shore a function that it had being conducting off-shore.

Nonetheless, as many a married couple will attest, sometimes there is just no patching up differences. “From a legal position, termination is a pivotal right,” says Mr Colvin. “It means that, if things are really hitting the buffers, there is an ability to walk away.”

Therefore, it is important to have in place robust legal exist arrangements to ensure that data, assets, contracts and licences are all transferred smoothly back to the customer or to a new outsource provider. “If you are in a termination scenario, when it is the result of supplier default,” says Mr Colvin, “you cannot at that stage be negotiating the basic principles of the exit arrangements because the supplier is not going to be willing to bend over backwards.”

Mayer Brown litigator partner Miles Robinson specialises in outsourcing disputes and advises that contracts are difficult to unravel if things go wrong because the outsourced elements are often critical to the business. “It’s a tough call to terminate a contract for breach, as there will generally need to be a lengthy transition period to the new provider to avoid business disruption. That can be difficult to achieve successfully for parties who are in dispute,” he says.

Mr Robinson says wrangles often arise because an outsourcing contract “isn’t adequately future proofed”. He cites the example of new technology becoming available with the potential to perform a function better while at the same or lower cost. “The outsourcing provider could be reluctant to provide that technology because the investment cost will eat into the revenue generated by the contract,” he says.

Outsourcing has become so popular that even some legal services can be sent to arguably cheaper and more efficient bulk providers. Indeed, ranks of lawyers at legal process outsourcing assembly lines in India and the Philippines, along with other jurisdictions, have cropped up over recent years to deal with much of the work that in-house trainee or junior lawyers would have done until only recently.

“When outsourcing legal processes, finding ways of using technology to streamline processes is key,” says Steve Holmes, the partner in charge of law firm Baker & McKenzie’s London outsourcing team. “You can’t underestimate the time you need to put in ensuring that an off-shore provider has the quality you need. You’ve got to look for suppliers that provide their staff with long-term career paths so the staff churn is low.”

TOP LEGAL TIPS

TAKING LEGAL ADVICE TO MAKE IT WORK

Any business considering outsourcing functions should take a lead from every boy scout and Baden-Powell’s well-known maxim – be prepared.

“Thorough preparation is critical,” says Mark Leach, partner and head of the international outsourcing practice at law firm Bird & Bird.

Businesses must ensure they have a clear understanding of any function being considered for outsourcing, carefully assessing how it currently operates and what kind of service levels are achieved internally.

If anything is certain in an outsourcing relationship, it is that a customer’s requirements will change over time

That process should be documented and communicated to all potential suppliers pitching for the contract. Bidders must also be given sufficient time to analyse and conduct due diligence based on that information. Without this process, says Mr Leach, “even the best supplier is unlikely to appreciate what it is taking on and its chances of improving the service over time will be jeopardised”.

Outsourcing arrangements are frequently complex and suppliers will usually need customers to continue to perform certain activities to enable the fulfilment of outsourced responsibilities. Failure to understand these dependencies and to document them properly in a contract can frequently trigger legal disputes down the line.

“If anything is certain in an outsourcing relationship,” says Mr Leach, “it is that a customer’s requirements will change over time.” Therefore, it is essential that the contract remains as flexible as possible. Businesses should build in practical and easy-to-operate procedures that enable new services or amendments to be scoped, agreed, and priced quickly and efficiently.

Businesses should also establish a contract governance framework combining regular service review meetings with continued involvement of senior players from both sides of the agreement. A well-designed framework will oil the wheels of the outsourcing relationship and foster a collaborative approach that enables change to be dealt with effectively.

Mr Leach advises businesses to be aware of potential legal issues, pointing out that it is crucial to take advice early. Certain organisations, such as those in the financial services or legal sectors, are subject to specific regulations that affect the way outsourcing must be structured and operated.

More broadly, legislation will be relevant to the transfer of employees, both at the outset and at the end of an outsourcing deal, and compliance with data protection legislation is critically important where a supplier is handling personal information relating to a business’s customers.

Ultimately, a well-drafted contract is crucial as it will provide a customer with essential protection against the legal risks inherent in outsourcing and an ultimate fall-back if the relationship falls apart.

But businesses should aim to achieve a balanced contractual relationship. Mr Leach concludes: “For an outsourcing to work, the supplier must remain incentivised and able to make a sensible return. A customer may feel that a one-sided contract provides superior protection, but in practice this is often an illusion. It is more likely to be damaging to the long-term viability of the outsourcing relationship and a project’s overall chances of success.”