Success in outsourcing key services
As your business grows, instead of taking on more staff, you may consider outsourcing certain services either on a short term or long term basis. There is almost no limit to the type of services that may be outsourced, from manufacturing and drop shipping to IT, marketing, payroll or finance support, customer facing roles, and sales support. As the world of freelancing has developed, you are also not restricted to finding a provider within these shores.
While outsourcing key services may offer an efficient way for a business to grow, it is not without risks to your business and its hard-earned reputation.
There are many key legal (and practical) issues to consider when drawing up your request for outsourcing proposals. Once you have found a preferred service provider, you then need to negotiate a commercial arrangement which provides you with the necessary protections should problems occur.
Your request for proposals should cover all your operations which you wish to outsource so that potential providers are clear about what they will be expected to deliver. But this is also the point at which you should gather vital information to help you assess the suitability of your preferred provider.
Some of the key issues on which you will need information include:
- Where is the service provider based? Will the agreement you sign with them be subject to English law? If not, you will need additional advice.
- Company structure and financial stability. It is sensible to undertake some corporate and financial due diligence on your preferred provider. Is there any risk it could collapse like Carillion did in 2018? Strong financial stability is key to ensuring the contract does not terminate unexpectedly and expose you to undue risks.
- If you are subcontracting your own obligations, you will remain liable to your customers. If your services provider causes you to breach your contract with your customer then you will want to hold that service provider liable for your losses and you will also want confirmation the service provider has adequate insurance in place to cover its liabilities to you.
- Compliance with Modern Slavery Act, Bribery Act etc. Depending on the nature of the contract, you may need to see the service provider’s policies on matters of compliance which affect the supply chain.
- Data protection. If you are relying on the service provider to assist you with any data management, then carrying out due diligence on its data protection protocols and putting in place suitable data sharing or processing contracts will be critical.
- IR35 and Managed Service Provider rules. Remember to ask your accountant or tax adviser about the tax implications of using a freelancer, personal service provider, or IT service providers working through agencies.
If the value of the contract is substantial, then it is worth asking our solicitors for input even at this early stage.
Once you have selected a preferred supplier, then we will help you to negotiate the commercial arrangement. There is likely to be an extensive list of issues to consider, but some of the key ones are as follows:
- Right to subcontract. The service provider may want the right to subcontract its obligations. However, it is preferable to prevent this so that the buck stops with the service provider and you have a tight line of control.
- Key performance indicators (KPIs). Agreeing KPIs, expectations and deliverables will be an important negotiation, and these will vary depending on the service and how time-critical or performance-critical they are to your business. For example:
- for IT services, KPIs could relate to minimum amount of uptime, frequency of upgrades, or timely turnaround on maintenance support;
- for manufacturing services, your KPIs would likely focus on minimum order quantities, quality test results, compliance with specifications, production times etc; or
- a book-keeping service might need to be up to date with latest accounting principles and software, submit information or filings by certain dates.
- Do you have any employees who are currently involved in providing the services to be outsourced? If so, what will happen to them? For example, will they transfer to the service provider?
- Price Review Mechanisms. If your contract is for long term supply then it is likely you will negotiate how the service provider may adjust its prices in future. Sometimes price adjustment is linked to RPI, sometimes there is a bespoke review structure based on an average of third party rates. You will also need to decide if the supplier may automatically increase its prices or whether it will need your agreement and, if it does need your agreement, what happens if you don’t agree.
- Transitional Services. Do you need a transitional services agreement to ensure the smooth transition of either the handover or hand back of the services to and from the services provider?
- How may the relationship be ended and what happens when it does end?
Contractual reporting and reviews.
Often once contracts are signed, they are forgotten, and the course of business takes over. It is good housekeeping practice to audit your contracts frequently to ensure the other party is not acting in contravention of the terms, to ensure there are no changes in the relationship that needs to be documented within the contract and, most importantly, that any variations and agreements outside of the contract take place in writing, preferably always with reference back to the original contract
Remedies for underperformance
One of the risks of outsourcing a service, is that it is not easy or quick to bring it back in-house if something goes wrong. Much as you hope this will not happen, it is important to be prepared and agree remedies in the event of failure or under-performance by your outsourced service provider. Some of the more common remedies that may be suitable to provide for in any service contract include:
- Should you receive a credit for service downtime? Should there be a chargeback for delay in manufacturing or shortages in order quantities? Would a reduction in fees apply if certain KPIs are not met?
- The right to terminate. You may consider linking any failure to meet KPIs with your right to terminate. This will give you an additional remedy specific to the risks you are most concerned about and may incentivise better performance. However, termination is a petty nuclear option so you may also wish to include dispute resolution and escalation procedures in an attempt to identify and resolve issues at an early stage.
- Intellectual Property. If you are outsourcing any creative functions then intellectual property (IP) rights are likely to come into play. It is important to have the right provisions in your contract and appropriate indemnities from your service provider to ensure you know who will own IP and who is responsible if that IP infringes third party rights.
- Rectification or replacement. You may consider including the right to require the service provider to rectify errors or work that does not meet the agreed deliverables. If the provider becomes incapacitated, a right to replacement (whether your choice or its) is another protection you might put in place to reduce the risk of service interruption.
- Termination notice periods and assistance. If in your contract your outsourced provider can terminate at will, it is always sensible to extend the notice period as it may take you a while to find another suitable outsourcing partner. This type of provision is just one example of how your business may be protected from unexpected loss of service. You may also wish to oblige the service provider to assist you to move the services back in house or to a successor provider.
How we can help
Our commercial team has extensive experience with helping businesses to navigate outsourcing services. Whether it is to help you negotiate the right terms in your contract or conduct due diligence on your selected provider, we can take care of your best interests.
For an informal discussion, please contact Victoria Spellman in the corporate and commercial team on 01473 350 573 / 07741 894 535 or email firstname.lastname@example.org.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.