Outsourcing – legal best practices
Outsourcing is the practice of engaging a professional third-party services provider for the provision of certain business processes or (supporting) activities. Incentives for outsourcing are e.g. cost reductions, improved quality and innovation. Due to COVID-19, we see that companies also consider outsourcing of activities as an effective restructuring and transformation tool; outsourcing non-core activities, with the aim to (re)focus on core capabilities and making the business more agile, lean and (cost)efficient. The below briefly addresses the process of outsourcing and share some legal best practices in outsourcing transactions.
Business activities that are frequently outsourced include payrolling, HR, financial administration, IT & software solutions, as well as facility services and management thereof. An outsourcing process can generally be divided in a number of phases or steps, of which the most common are visualized in the picture shown below.
It is generally preferred to understand and define the key legal aspects, such as legal structuring, main contracting terms and conditions and applicable (internal) policies, in an early stage.
During the early phases of the outsourcing process, it is recommended to avoid detailed discussions and to focus on the main and key aspects of the transaction. In view thereof, it may be helpful to prepare ‘letter of intent’ or ‘term sheet’. A term sheet can be used to describe the overall structuring, timing and main terms and conditions for the process of entering into the envisaged outsourcing relationship. The content of the term sheet can also form the basis for the final contract documentation.
The contractual outsourcing arrangements are generally documented in a so-called ‘master services agreement’ or ‘MSA’, combined with certain additional contracts (such as a ‘service level agreement’ or ‘SLA’, see below). As the cooperation is entered into for a long(er) term, a MSA qualifies as a long-term agreement (‘duurovereenkomst’ in Dutch) for the provision of services.
An outsourcing transaction sometimes also entails the transfer of assets and liabilities closely related to the relevant business processes. Often certain employees, existing contracts or other assets will (need to) be taken over by the services provider. The legal transfer of these items needs to be appropriately addressed in the MSA (or other agreement).
The operational, legal, financial and other aspects of the outsourcing require appropriate attention and alignment. In that regard, a multidisciplinary approach is preferred. Forming a team with the right subject matter experts will proof useful in designing and forming the desired partnership.
Balance, flexibility and transparency
As the COVID-19 pandemic has shown, it is impossible to anticipate any and all possible events that may happen in the future. Given the long term and partnership focus of outsourcings, a best practice is to ensure the partnership is flexible and able to anticipate and absorb changes (operational and financial), whilst still ensuring continued delivery of services against the agreed quality. In addition, balance, transparency and evaluation form key items of fruitful outsourcings.
Therefore, key legal provisions of the MSA are (i) efficient governance arrangements, (ii) clear financial agreements, (iii) variation and change management procedures, and (iv) appropriate information and transparency rights and obligations (such as periodic reporting and audit rights). Careful drafting of these clauses is likely to enhance the effectiveness and long-term success of the outsourcing.
Quality and KPI’s
A key element of the MSA concerns the arrangements regarding service quality. The technical details, service levels and applicable ‘key performance indicators’ or ‘KPIs’ are often specified in a separate SLA. These arrangements describe the core obligations of the services provider. Therefore, clear contractual provisions should be in place to monitor performance and deal with correction of errors and non-performance.
To come to a successful and long-lasting outsourcing partnership, it is important to ensure that the business activities and expectations of the company and the service provider are aligned and that the parties find the ‘win-win’. In addition, the partnership should have the right level of flexibility to enable the parties to effectively implement changes, both from an operational and a financial perspective. A well drafted outsourcing contract should appropriately address these elements.