How to negotiate an international outsourcing contract

Many companies have considered outsourcing a broad range of business processes, including IT services, to achieve critical cost savings. Although this kind of agreement can be structured in many ways, a thoughtful contractual arrangement, with appropriate cost sharing, pass-through mechanisms and pricing adjustments, allows the parties to share certain risks and at the same time establish a productive and profitable relationship.

International outsourcing agreements present challenges to both the vendor and the customer. Typically, the vendor will be asked to coordinate a staged, worldwide rollout of services with little time to perform adequate business and legal due diligence before pricing, much less rolling out, the services. On the other hand, the customer will be faced with the risks to their performance, costs and reputation of partnering with a service provider. Thus, both parties must carefully evaluate the ostensible value proposition of outsourcing: a better, more reliable product at a lower cost. Practically speaking, as much as the customer wants superior services at a lower cost, the vendor can't act as the insurer of every business and legal risk.

Scope of the Agreement

First and foremost, both parties should be careful to avoid problems with pricing and scope of services -- or, as it's more commonly described, "scope creep." In most circumstances, the vendor will charge a base price for services and use separate adjustments and fees for additional services, such as per-project consulting. Thus, early in negotiations, the parties should openly and honestly discuss the scope of services, especially if the vendor plans to negotiate subcontracts.

For example, in IT outsourcing agreements, if the customer wants ad hoc administrative services, it may be preferable for the parties to negotiate a hybrid model of fixed and variable fees. In addition, if the customer needs to adjust the scope of services at certain milestones (for example, annual review based on usage patterns or upon a significant merger or acquisition), both parties should consider how the elimination or addition of certain services affects the margins. If the price for base services combined low- and high-margin countries into a "blended rate," eliminating high-margin services could significantly change the value of the contract.

Structure of the Agreement

At the same time, structural problems associated with global contracts can significantly affect the relationship between the parties. For example, the mechanism for measuring compliance with service-level agreements on a per-country or global basis must be clearly understood. To provide for reasonable penalties in the form of credits or liquidated damages, the parties must understand the mission-critical performance standards as well as the effect of measuring performance in different ways.

Similarly, when addressing payment issues, the parties should examine how fluctuations in currency will influence the contract. If the vendor pays its employees or subcontractors in local currency and invoices the customer in U.S. dollars, the parties must determine who should bear this currency risk. In the big picture, any ambiguity in international outsourcing agreements will lead to inefficiency and extra costs.

International Issues

The parties must also address the requirements of international law, including intellectual property laws and other country-specific rules and regulations. For instance, foreign labor laws could greatly complicate a customer's plan to transfer its employees to the vendor. In European Union countries, legislation enacted under the European Commission's Acquired Rights Directive generally provides that transferred employees be given the same or comparable employment terms and benefits, including severance packages.

Similarly, legislation enacted under the European Commission's Data Privacy Directive could prohibit the transfer of personal data to non-EU countries unless certain additional notice, consent and security requirements are satisfied. Because U.S. privacy laws don't provide protection that's judged adequate under the EU Data Privacy Directive, cross-border transfers involved in the outsourcing agreement will be prohibited unless the parties take steps to satisfy additional EU standards. In this kind of situation, the parties should negotiate cost-sharing or pricing adjustment mechanisms on a per-country basis, especially if the customer does business in a heavily regulated industry such as banking, insurance, financial services or medical services.

The complexity of international outsourcing agreements requires a unique blend of business and legal expertise. By better understanding the issues, companies can negotiate an appropriate contractual relationship and achieve necessary cost savings.

Gene T. Barton Jr. is a partner in the corporate department at Choate, Hall & Stewart in Boston. As a member of the Business & Technology Practice Group, he specializes in the representation of emerging companies, closely held businesses, and venture capital and private equity firms.

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