June 2003

Corporate outsourcing - Tackling the legal risks

Originally a product of the early-1990s wave of corporate restructuring that continues to this day, outsourcing has become an accepted feature of doing business in corporate Australia.

Outsourcing relationships have evolved from one-dimensional contracts based on cost savings to multidimensional "partnerships" that support the core business of client corporations. Although rarely is it intended that there be a "partnership" in the legal sense.

Legal issues

It is essential that you understand and accurately record the rights and obligations of each participant when outsourcing, otherwise there will be a greater risk of a problem occurring.

The evolution of outsourcing now means that the legal issues that arise in an outsourcing arrangement may span across several legal areas, such as information technology, tax, intellectual property, employment, regulatory, security, corporate, insurance, real estate, and dispute resolution.

The issues that arise within these legal areas include -

  • The status and relationship of the participants

  • General risk issues, such as limitation of liabilities, indemnities, insurance, potential negligence claims and warranties

  • Performance guarantees, such as KPIs and service level requirements

  • Ownership of and rights to use intellectual property, such as copyright and moral rights

  • Privacy and security of information

  • Occupational health and safety

  • Conflicts of interest

  • Dispute resolution

  • Possible regulatory controls and impact of competition laws

  • Licensing and sublicensing of technology

  • Publication and controls on the use of the name of the parties

However, before you even consider how to deal with all the legal issues that may arise it is crucial that you and your lawyer take the time to understand -

  • Why are you outsourcing?

  • What are you outsourcing?

  • Who are your stakeholders?

In our experience, many outsourcing agreements are flawed because they focus too much on costs and defining the inputs rather than on the required outcome. Understanding the why, what and who questions can help keep you focused on the required outcome when negotiating an outsourcing agreement.

Why are you outsourcing?

There are many reasons why a business may decide to outsource ancillary or business process functions, including -

  • Reduction of operating costs

  • Best practice and service enhancement

  • Specification of service levels

  • Improved performance monitoring

  • Defined outcomes

  • Up-skilling

  • Greater management focus

What you are outsourcing?

It is obviously important to understand what is being outsourced to ensure that the outsourcing arrangement will live up to its expectations. A poorly specified scope of services usually leads to poor delivery and a strained relationship with the service provider.

When scoping the services to be outsourced the following general rules should be considered -

  • Outsource responsibility for service delivery rather than accountability

  • Outsource generic processes rather than core strategic competencies or sources of competitive advantage

  • Outsource risk rather than liability for poor delivery

Following from this, services that are difficult to specify and are core strategic competencies should remain in-house. Those services that are easy to specify and are generic processes are the services that should be considered for outsourcing.

Outsourcing should only then be undertaken if there is a high likelihood of realising a financial benefit. To know this, you need to understand the cost baseline of the insourced service which should be analysed to determine which costs can or cannot be saved under the proposed outsourcing model.

Who are your stakeholders?

The impact that an outsourcing arrangement will have on the stakeholders may influence the way the deal is negotiated. The stakeholders generally include -

  • Management

  • Staff

  • Unions

  • Internal User Groups

  • External Service Provider

  • Customers

  • Shareholders

  • Public

Tackling the legal risks

Only after you and your lawyer have taken the time to understand the why, what and who questions will you be ready to deal with the various legal issues.

It is important to remember when tackling the legal risks that there is no universal solution or approach. Outsourcing can touch on a wide range of legal areas, so it is important to focus on having the right people sitting at the table - that is, the right management team, the right service provider and the right lawyer.