Transferring responsibility for a business function through an outsourcing agreement with an outsourcing supplier may be one of the most important commercial contracts you enter into to scale up your business. An outsourcing agreement helps to ensure the arrangement meets your current and future business requirements.
Here, we look at some key considerations when agreeing to outsource services. And remember, our team of friendly, experience commercial solicitors can help explain, advise on, negotiate, draft or review your outsourcing agreement to ensure a successful relationship between parties.
Outsourcing involves the delegation of responsibility for a specific business task to a supplier. It can include the transfer of employees or assets or software used to carry out the outsourced function from the business to the supplier.
The outsourcing agreement is one element of a successful outsourcing arrangement. It is essential you take time to:
An outsourcing agreement allows a business to confidently hand over a function of the business with contractual guarantees on service and price and for the supplier to accept responsibility for the business function knowing what is contractually expected of them and the outsourcing pricing structure.
The outsourcing contract should carefully define the parties to the agreement when the business or the supplier is part of a group of companies. Guarantees for liability may be required from the parent company if the outsourcing supplier is a subsidiary company.
The outsourcing agreement should also cover:
When outsourcing a business function, the length of the agreement needs to be carefully assessed to meet your current and anticipated business needs. For example, you may be anticipating a change in the business model that will enable you to move the function to an overseas supplier with enhanced cost savings or technological advances through automation will negate the need for outsourcing. Therefore, you need to look at the length of the outsourcing agreement and the termination provisions.
If flexibility is required, a business may negotiate a clause giving the ability to terminate the contract on notice to the supplier before the end of the contract in circumstances where there has been no fault or breach of contractual obligations by the supplier. This type of termination clause may need to be negotiated if the outsourcer is taking on some of the business’s assets and employees as the supplier will want assurances that they will not incur significant set-up costs only to find themselves with business assets and transferred employees they no longer require.
One option to satisfy the competing needs of the business owner and supplier is to agree on a sliding scale of termination charges if the business gives early notice without fault to the third party. That way the supplier is recompensed for the losses they will suffer if the contract is terminated early. Termination charges may be more cost-effective for the business if, for example, the direction of the business changes (to no longer require the outsourced function) or outsourcing overseas or the use of automation offers a significant reduction in overheads.
A business owner, whilst wanting flexibility, may also value continuity of supplier. The outsourcing agreement may therefore include a minimum contract term but with rolling notice at the end of the fixed term.
The outsourcing agreement should include:
It is important to both business and the supplier to get the pricing structure right so that outsourcing is a cost-effective solution for the business and the returns to the supplier ensure they are motivated to meet agreed service levels.
Price and charging regime options include:
When considering pricing, some suppliers try to agree on an upfront payment to cover set-up costs for supplying the outsourced service. It is a matter for negotiation if installation costs are paid upfront, paid in instalments over the life of the contract or the contracted price simply reflects the supplier’s initial and ongoing costs.
The business and supplier also need to consider cost review clauses to provide for price increases in line with the retail prices index or other sector-relevant indexation. Commercial solicitors will look at how termination clauses (such as termination by notice where there is no breach of contract) fit with price escalation clauses. In a period of rising prices, your business may not want the third party to have the right to terminate on notice as you may not be able to match the outsourcing price when looking for an alternative supplier to take over the outsourcing function.
When employees are transferred from the business to the supplier it needs to be carefully managed and handled to avoid the business suffering adverse publicity. The outsourcing agreement should address:
TUPE normally applies to the transfer of employees in outsourcing arrangements so the contracts of employment of employees involved in the outsourcing function transfer from the business to the supplier at the start of the outsourcing agreement. Importantly, if the outsourced services go back in-house to the business, the employees are subject to TUPE provisions again. For more information on how TUPE can affect a business and its employees read our article on the TUPE provisions.
If the outsourced business function involves the use of property or equipment then the business may choose to sell, lease or loan the property to the supplier or they could provide their own equipment or premises. The outsourcing agreement needs to address:
It is best to consider all options as, for example, lending equipment that will be surplus to the business’s requirements once outsourcing has taken place may drive down the price of the outsourcing contract.
It is best to check and address any IP issues in the outsourcing contract. For example:
If the supplier will be processing personal data on the business's behalf as part of the outsourcing function, then the supplier must be GDPR compliant. The GDPR states what contractual terms a business must include in their data processing contracts and specifies matters such as how the supplier (data processer) should process the data, the maintenance of records and security, systems in place to respond to data access requests, and for the deletion or return of data to the business.
Outsourced data processing must comply with The Data Protection Act 2018 and The General Data Protection Regulation (GDPR). Under the GDPR, a supplier is subject to direct compliance with GDPR obligations on data protection. Non-compliance could result in the supplier facing penalties. For more information on data protection read our articles on handling personal data and supplier data protection breaches.
It is usual to include industry-specific and general warranties and liability clauses in outsourcing agreements. It is preferable to negotiate warranties rather than rely on warranties implied by law. Common warranty and liability clauses include:
The ability to monitor performance and conduct audits enable the business to review the supplier's performance and compliance with agreed service levels. Through effective outsourcing contract management, any potential issues can be identified and resolved before escalating into a potentially costly dispute.
It is best practice to record matters such as:
In some outsourcing agreements, where the outsourced business function is critical to the success of the operation of the business as a whole, it may be prudent to include step-in rights as part of the outsourcing contract. That means that if the level of service by the supplier remains below-agreed standards, despite an increased level of monitoring, the business can exercise step-in rights and take over management control of the outsourced services until the supplier can show it can meet service levels.
Early termination of an outsourcing contract enables a business to take the function back in-house or open up the outsourcing tendering process again or offer the outsourced function to a second preferred supplier. The termination provisions and rights must be carefully drafted and take into account any industry-specific issues. For example, the impact of the supplier losing professional or industry-related accreditation or being unable to secure insurance.
On a practical basis, ending outsourcing normally cannot occur instantly so it is important to ensure the outsourcing agreement contains an exit plan so the termination of the outsourced function takes place in an orderly fashion without too much damage to the business. The exit management plan should cover matters such as:
The plan can go into more detail depending on the significance of the outsourced function to the business and the likely complexity of any transfer back in-house or a new supplier.
For more information on termination clauses read our article on terminating a commercial contract.
Our team of commercial solicitors provides joined-up commercial law advice on all aspects of negotiating the agreement and resolving any employment, IP, or GDPR aspects of the contract as well as advising on dispute resolution if there is a falling out between business and supplier. We also can help you review your existing outsourcing agreements to ensure they remain fit for purpose and provide you with the agility and pricing and termination structure that ensures outsourcing remains a viable option for your business.
About our expert
Kevin joined the commercial team at Harper James in 2022 and brings over 20 years’ experience working in private practice on a range of commercial matters.
