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12 May 2022

IT Outsourcing Contract Clauses You Should Know, Include, or Avoid

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Before you begin your next IT project, it’s a good idea to acquaint yourself with the ground rules. Of course, even if your initial meetings get off to a great start, your job as a manager is to prepare for any eventualities, and to engage in the correct legal due diligence.

As with any business practices, you should be prepared to formalise. Of course, much of this means knowing what to include in your formal arrangements.

Outsourcing offers a world of opportunity. But without a sound understanding of the legal requirements, you may miss out on some of the most critical benefits. This article will examine what outsourcing contract clauses and conditions you need to keep in mind, which are definite terms, and what kinds of clauses to avoid.

Introduction to contract clauses

When working with software companies, it’s common to outsource. This practice has existed for decades but has evolved to account for business practices in the digital age.

It’s important to note that this practice applies to both long and short-term business dealings, as it provides relief for staff in engaging in core business activities. These include accounting, payroll, marketing, and administrative functions.

What you should have

As we’ve stated in some of our other publications, there are many ways to determine the viability of a software development partner, particularly when they are remote companies, in nearshoring locations.

Remember, a commitment to a legal framework is itself a good sign of your partner firm. Now, it’s time to explore the conditions and clauses that make up the body of this framework.

1.      Introduction

Two key details to note here are firstly, a specific and detailed presentation of parties. This is so that it is unmistakable who is a party to the agreement, and what is its legal form. Secondly, the intro must ensure that the party is represented by the appropriate person. In such cases, we want to avoid unauthorised agents or ‘ falsus procurators .’

2.      Essential clause for drafting

a.       Purpose

There are three popular ways of outsourcing IT services. It should be clear from the beginning which path is selected. The choices are:

  • Extending a team through an external sub-team billed for time & materials (TM)
  • Body leasing one or several specialists (usually billed under a TM agreement)
  • Delegating specific tasks or a whole project billed at a fixed price (FP)

b.       Benchmarks

This part of the agreement depends on the chosen cooperation path. With FP or TM-billed projects, there should be specific documentation – such as an appendix, citing bodyleasing or team extension. This could take note of required professional criteria, such as diligence and professionalism. For example, a clause can identify all workers should be senior IT engineers with a certain experience in technology ‘X.’

c.       Transfer of assets

This regards what is shared with the contractors’ personnel. Items include devices, software, or credentials to IT environments. Here, we can expect to find the contractor’s defined liability for these, how are they returned, etc.

d.       Representation and warranties

IT companies tend to differ between the liability subject to the chosen cooperation method. For example, in bodyleasing, the contractor often seeks to remain liable for only matching the ordering party’s requirements in team composition. Examples of this include a required specialist’s seniority or experience.

In FP-billed projects, the contractor would remain liable for the compliance of created software with the software documentation and other ordering party’s specific requirements. Therefore, this clause exists mainly for the result of team’s services. Oftentimes, this contains an additional guarantee.

e.       Ownership of product

This subclause is usually stipulated in the intellectual property rights clause. As is most often the case, contractors are ready to sell all their rights, titles, and interests to all results of their services. This is conditional that they’re paid for the services.

Therefore, the ordering party remains free in any future use and development of the software. The essential thing to note here is also the acceptance procedure. This takes into account several factors:

  • How often an ordering party may inspect results of the services
  • Tests to be performed
  • Who tests, and who pays for removing errors - if applicable
  • Acceptance protocol signed by the parties
  • Persons authorised to perform acceptance procedures
  • Possible ‘silent consent’ acceptance methods

f.        Intellectual property rights (IPR)

These should be carefully distinguished between the original results of contractors’ personnel services. The factors here include:

  • Complete software, or components of it
  • Being a subject of their IPR and thus sold under the agreement to the ordering party
  • External subjects of IPR used in such a cooperation:
    • Pre-existing fonts
    • Libraries
    • Multimedia such as icons, photos, animated items, et. al.
    • Other works that are licensed by the contractor, which result in the license being transferred to the ordering party
    • Open-source licenses, copylefts, free software, et. al.

g.       Payment clause

There are two leading methods of settling payments with a contractor:

1.       Fixed Price (FP)

Here, there is a pre-agreed amount of the contractor’s remuneration. It is paid when a service is completed by the contractor and accepted by the ordering party.

2.       Time & Materials (TM)

Here, there is only a remuneration rate for a single unit of service, such as an hour or day. The total amount of remuneration depends on the total number of ‘units of service’ that have been completed by the contractor’s personnel.

What this means is the amount to be paid is flexible, while in fixed price projects, it is specific and understood from the beginning.

It’s also important to state when an invoice may be issued, the payment method and terms, as well as any further requirements. If the invoice is not paid on time, for instance, the contractor could be permitted to pause activity and services until it has obtained all the outstanding payments. It is recommended to ensure a contract addresses this as agreed milestones could then become subject to a postponement.

h.       Duration for completion

The schedules for performing specific services in an FP project may be agreed upon from the beginning. A TM project may require adjustment to the subject of the evolving scope of cooperation and actual development progress.

i.         Dispute resolution clause

It’s essential to decide on the course of action for addressing legal conflicts. Here, it’s possible to determine if disputes can be resolved amicably, through arbitration, or via common court. The clause should also identify the person(s) paying, as well as steps to take in case of third-party involvement.

j.         Sub-contracting

IT services are often outsourced and may involve freelancing IT specialists who will be formally considered subcontractors. The agreement should ensure what level of subcontracting is possible.

  • In terms of liability, the subcontractor is treated equally to members of the contractor’s personnel, i.e., the contractor remains liable for such an external specialist
  • It is a contractor’s obligation to ensure that the IPR are gathered from the subcontractor so they may be further transferred to the ordering party
  • It’s the contractor’s obligation to ensure the security and proper configuration of the subcontractor’s assets, such as devices and software, connecting them to a contractor’s or ordering party’s networks, etc.

3.      Other clauses for consideration

  1. Indemnification clause

A force-majeure clause states that neither of parties are liable for certain events outside their control and prediction, such as war, pandemic, or natural disaster. A proper indemnification clause, where we establish a delimitation of parties’ liability can state that the contractor agrees to indemnify and hold harmless the ordering party also from other circumstances, such as any alleged copyright infringement claim and/or the costs of such a court dispute.

  1. Termination clause

An agreement can have three ‘layers’ of stipulations on its existence in time:

  • How long the agreement should remain in force – for ‘X’ period, or indefinitely
  • If it may be terminated unilaterally by issuing notice & identified agreed notice period
  • If it may be terminated unilaterally without notice – with causes of such termination

Some legal frameworks use also more specific instruments, such as a rescission. In this case, the contract is considered as if it has never been concluded by parties, so after a legally effective rescission, parties need to return to each other everything they gave, paid, or executed in its performance.

In any such clause it is worth identifying an exit plan. Here, you would determine what happens to the software, especially if it is already operating, or to any data stored in the software or infrastructure.

Included within your upcoming outsourcing agreement

  • Scope and performance of services
  • Dates of agreement
  • Provisions for termination
  • Pricing and fee structure
  • Payment terms
  • Representations and warranties

Variation of the scope

As the ‘variation’ has not been covered before, remember about setting a specific delimitation between:

  • Managing faults and errors discovered within the acceptance procedure. These factors must be corrected by the contractor within the warranty and under basic contractor’s remuneration.
  • Managing change requests or alterations with new requirements to the scope of services. These are submitted by the ordering party because of inspecting the software, and may be introduced by the contractor, but should be paid for by the ordering party separately, as for a new service.

What kind of provisions to avoid

A leading cause of dispute, and one that’s most costly to reverse is a written outsourcing contract that is poorly aligned to business outcomes. Oftentimes, when there is a contract form used and it does not match the project where the contractor is hired. This can occur when an agreement template is inherited from a previous business agreement.

Additionally, an unbalanced agreement can also fall foul of being respected in the future. In some cases, when a contract favours only one party to the agreement. Good examples of balance-induing measures include clear requirements, transparent schedule, acceptance criteria, budget’s outline, confidentiality protection, IPR transfer, exit plan, or warranty. Overall, a balanced agreement gives more chance that the parties will not try to bypass it or breach, increasing the chance of a dispute.

Examples of contractual errors:

  1. Agreement is concluded without checking the other party’s entity, its legal form, the authorization of those who signed it or with no appointment of parties’ representatives
  2. There’s no ordering party’s control over who will perform the contractor’s services (e.g., who may be the subcontractor, how the team composition may be changed in case of objections to services’ quality)
  3. There is no documentation, schedule, or budget – or it is unclear how the scope of the agreement is agreed upon and modified when circumstances alter and how that impacts timeline or costs of cooperation
  4. Ordering party is granted just with a license, while the IPR transfer is paid separately or remains a subject of an exaggerated (costly or time-consuming) formality
  5. There is no stipulation on external IPR such as the open-source components
  6. Warranty is excluded and there is no guarantee or either of them is unclear
  7. There is no termination clause, or causes of the termination without notice or exit plan
  8. There are no clauses on confidentiality, data protection, non-compete, etc.
  9. Contract Terms that state the buyer pays all costs related to Exit Management
  10. Contract Terms that exclude your supplier’s advice and representations
  11. Contract Terms that present KPIs that are not aligned to project objectives
  12. Contract Terms that limit a client’s remedial capabilities
  13. Contract Terms that exclude client’s costs should outcomes not be met
  14. Standard Contract Terms for additional project work

Final thoughts

With the scale of such working arrangements, it’s understandable that outsourced relationships can often be punctuated with opportunities for controversy. By taking some of the above advice, you can formulate an agreement that adheres to your organisation’s requirements and help achieve the objectives of your project.

Ensure you commence your collaboration with a trusted, and experienced outsourcing team. By selecting a valued partner, you can be more certain of a productive working relationship that is both honest, productive, and well-defined as per your agreement. Take particular care of creating a tailored outsourcing agreement that aligns with your goals, in addition to defending the integrity of your working relationship.

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Author
Piotr Jać
Head of Legal Department

Lawyer, specializes in comprehensive services for companies from the IT and technology industries.