A guide to Mitigating Risks when Outsourcing
Outsourcing can offer many benefits to your business, such as cutting costs, increased efficiency, risk management, as well as many others, and is especially popular for startups.
While outsourcing can be very advantageous, there are risks and requirements that need to first be considered. As outsourcing becomes increasingly more popular, it is important as a tech startup that you are aware of the various elements of outsourcing your business activities and the consequent effect on your business.
Here we will go over everything you need to know about outsourcing transactions for your technology business.
What is the procurement process of outsourcing transactions?
The procurement process depends on the specific transaction, however, usually consists of:
Request for proposal
The customer will set out a process for which it intends to appoint a supplier. Therefore, they will include their requirements, legal terms and conditions that will be subject to the contract, and any other information that prospective suppliers need, or that they need from the suppliers.
Any potential suppliers will need to provide their proposed solution, price and provide any areas of the request for proposal that they would like to make changes to.
Often as due diligence, workshops will be held so that customers can gain a better understanding of the supplier’s proposed solutions, and also so that suppliers can gain a better understanding of what is required of them. This will ensure that both parties are able to meet the expectations of the other.
There are no laws in Australia that specifically apply to outsourcing, however there are certain regulations and rules that apply to specific sectors, that must be considered depending on the sector in which you work.
Outsourcing in the financial services sector
There is an Australian Prudential Standard that provides rules on financial services institutions outsourcing their material business activities.
Material business activities meaning those that have the potential, if disrupted, to have significant impact on the business operations or its ability to manage risks effectively.
Several factors will impact whether a business activity is considered material, including:
- Financial, operational and reputational impact of a failure of the supplier;
- The cost of outsourcing as a percentage of the total costs of the business;
- The degree of difficulty in bringing the activity in house, or finding an alternative service provider.
There are three main categories of obligations of a financial services institution that is outsourcing business activities
Policies and procedure
Financial services institutions must have in place policies and procedures to manage outsourcing of material business activities
Must meet the Australian Prudential Regulation Authority’s (APRA) standards when selecting the supplier
There must be a legally binding contract that contains matters set out in the Australian Prudential Standard.
If the outsourcing activities involve delivery of any services from outside of Australia, then the APRA must be consulted before entering into the contract. You must ensure that the risks involved in offshoring are managed in order for APRA to approve the contract.
Any telecommunications and internet service provider is required to notify the communications access coordinator if there is a change to their systems that could have an adverse affect on its ability to secure its systems. This includes forming an outsourcing agreement.
The commonwealth public sector and all non-corporate Commonwealth entities are governed by a number of legislations and rules. Each state also has regulations governing outsourcing by the public sector.
What if I need to transfer or lease assets as part of the agreement?
Often under an outsourcing agreement, it will be required that a party must lease or transfer their assets to the other – usually the customer to the supplier. You may find yourself in the position that you need to lease or transfer one or more of the following:
- Real estate – Any transfer of land must be registered, but each state has specific laws on the transfer or leasing of land;
- Intellectual Property – Under an outsourcing contract you may want to grant a license in respect of copyright or for any patents or trade marks;
- Moveable property – Usually can be transferred under the agreement without registrations;
- Key contracts – If either party wishes to transfer all of their obligations and rights under the contract, consent will be required by all parties to the agreement;
- Data – Data that is not subject to copyright cannot be transferred as property, however contracts can provide for the transfer of data and information.
Can employees be transferred in an outsourcing agreement?
Sometimes in an outsourcing agreement employees may need to be transferred between parties, this usually occurs from the customer to the supplier.
The employees of the customer do not become employees of the service provider, and the law does not permit employees to be individually assigned to the supplier.
The employees can be transferred to the suppliers where:
- the supplier makers an offer of employment;
- The employee accepts the offer.
In this case, the employees will cease employment with the customer, and become employed by the service provider.
How are data and privacy protected under outsourcing agreements?
The Australian Privacy Principles (APPs) are found within The Privacy Act, and these contain rules in regards to the collection, use, storage and disclosure of personal information. Most private organisations are required to comply with the Privacy Act, except for some small businesses with a turnover of $3 million or less.
The APPs will need to be following in regard to the collection, use, storage and disclosure of any personal information that arises as a result of the outsourcing transaction.
What are the elements of an outsourcing agreement?
Specifying the service to be provided
Under most outsourcing contracts, the customer will prepare a description of the services to be provided by the supplier, which will be incorporated into the contract.
Fees and payments
Under outsourcing agreements, payment methods and fees are often the area of your agreement that will be subject to the most negotiation.
The agreement will likely consist of both variable and fixed charges.
Consumption based charging structures are the most common in outsourcing agreements, where the customer is only charged when the service is used.
Often in outsourcing agreements, there will be included a right for a customer to audit the service provider’s fees. This will allow the customer to ensure they are being charged correctly.
There will often also be the right to benchmark the supplier’s fees, where the fees are compared to other companies and competitors. Commonly the outcomes of a benchmark include: price adjustments, a remediation plan to bring the price down, and termination without penalty by the customer.
Audits and benchmarking usually occur in set intervals, and the customer most often bears the cost.
Warranties and indemnities
Warranties under an outsourcing contract are often in regard to:
- The legal capacity of the supplier to enter into the contract;
- The ability of the supplier to perform the services required (e.g. do they have sufficient resources);
- The supplier having the required rights such as IP rights, required to provide the services;
- The quality of the work provided by the service provider, including whether the services are performed professionally and meet specifications.
Often the indemnification clause will indemnify either party in regard to: personal injury, death, third party IP claims, confidentiality and privacy breaches and property damage.
The Australian Consumer Law (ACL) may also apply to outsourcing agreements, in regard to consumer guarantees and unfair contract terms.
Liability and Insurance
Often liability will be excluded for:
- Indirect loss;
- Consequential loss;
- Loss of profits;
- Loss of revenue;
- Loss of savings;
- Loss of business opportunity.
You may want to consider agreeing to a cap on liability, which will provide that both parties are only liable up to a certain amount. The amount agreed upon will be dependant on the value of the contract.
Can the service provided be required to maintain insurance?
Usually the customer will require of the service provided to maintain insurance such as public liability, product liability, property insurance and professional indemnity insurance, however there are also others that may apply.
What happens if the agreement is breached or terminated?
The remedies available to the customer will depend on the nature of the breach by the service provider, the extent to which the supplier contributed to the breach, and any steps that they took after the breach.
Termination and consequences
Outsourcing agreements generally provide express rights to terminate the contract due to specific circumstances, such as:
- A breach by the other party;
- There is a change of control of the company;
- One of the parties wishes to terminate the contract for any reason;
- One party endures an insolvency event.
There are other numerous termination clauses that may be included, and usual contract law rules will apply here.
It is common for contracts to include a dispute resolution clause, which provides a process to resolve any disputes before the matter is escalated and the parties resort to litigation.
What happens after the contract ends?
You should have an existing management plan in place to ensure that the services continue at the same standard once the agreement ends. For example, it should address the return of assets, software, and intellectual property.
Outsourcing business activities can provide many benefits to your tech startup, however it is important that you are aware of the rules and regulations that apply to outsourcing, as well as the elements of an outsourcing contract, and seek the advice of legal services when engaging in an outsourcing transaction.
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