Key Takeaways

  • An outsourcing agreement is a legal contract outlining the terms for a service provider to perform specific business tasks on behalf of a company.
  • These agreements should clearly define services, deliverables, performance standards, payment terms, intellectual property rights, and confidentiality obligations.
  • IT outsourcing is common and may include business processes, customer service, and data backup operations.
  • Strong agreements address measurable outcomes, fair pricing, relationship management, and clear exit strategies.
  • Outsourcing contracts differ from general contracts because they specifically delegate business functions to another party.
  • Common types of outsourcing agreements include project-based, dedicated team, and time-and-materials contracts.
  • Detailed termination clauses, warranties, governing law provisions, and data protection measures are critical to avoiding disputes.

An outsourcing agreement is a contract formed between a company and a service provider wherein the provider promises to deliver specified services. An example would be data processing from a service provider that utilizes its own staff and equipment, typically working from their own location as well.

IT Outsourcing

Outsourcing IT systems operations is common, with some businesses opting to outsource their entire IT division either domestically or internationally. In these situations, businesses typically work very closely with an outsourcing service provider. These tasks are among the most commonly outsourced:

  • Business processes
  • Customer billing
  • Customer service
  • Server and desktop applications
  • IT backup and recovery services

The benefit of outsourcing IT services can include reduced costs and the flexibility to ramp up operations when needed.

Types of Outsourcing Agreements

Outsourcing arrangements can take several forms depending on project scope, business needs, and budget:

  • Project-Based Agreements: Ideal for defined, short-term projects with clear deliverables and deadlines.
  • Dedicated Team Agreements: The service provider allocates a team that works exclusively for the client, often on ongoing tasks.
  • Time and Materials Agreements: Flexible contracts where payment is based on the actual time spent and resources used, suited for evolving projects.
  • Managed Services Agreements: The provider takes full responsibility for a specific function, such as IT infrastructure management or payroll processing.
  • Build-Operate-Transfer (BOT) Agreements: The provider sets up and runs operations before transferring control to the client after a set period.

Selecting the right outsourcing agreement depends on the complexity of the work, the need for flexibility, and the level of oversight the client wishes to maintain.

Guide to Starting an Outsourcing Contract

While they can be complex, good outsourcing agreements contain important information:

  • Service expectations
  • Any potential penalties and/or awards
  • Expected timeframe
  • Reviews
  • Potential exit strategies

It's a smart idea to sit down and work on developing a clear definition of what is to be outsourced and what is to be left to your business to handle. Having the right legal agreement is the central core of a good outsourcing agreement, so seeking expert legal advice ahead of time is a smart decision. The agreement needs to be fair and clear from the inception, in addition to clearly defining what services are being outsourced. 

Formally agreed-upon targets, like service levels, can be a list that is as long or short as the business requires. They should be formed using detailed schedules so neither side has confusion or doubt about what is required of the service provider. 

Termination conditions can cause disputes, especially if there is some type of transition and handover to a new service provider. Good termination clauses or exit strategies should be in place from the start and continue after the end of the contract.

Risk Management in Outsourcing Agreements

To protect both parties, outsourcing agreements should anticipate and mitigate potential risks:

  • Performance Risk: Define service levels with measurable benchmarks and include penalties or incentives tied to performance.
  • Operational Risk: Require robust business continuity and disaster recovery plans.
  • Security Risk: Mandate compliance with applicable data protection regulations and outline cybersecurity measures.
  • Dependency Risk: Avoid over-reliance on a single provider by including provisions for transitioning to alternative vendors if needed.
  • Reputational Risk: Address quality control, compliance with laws, and ethical standards to safeguard brand reputation.

Including these protections ensures that the outsourcing relationship remains stable and adaptable even under unforeseen circumstances.

Elements of a Vested Outsourcing Agreement

There are some important things to remember when working on creating an outsourcing agreement:  

  • Focus on the overall outcome by completing a business model map first. Then work on a joint vision and statement of intent that will help provide guidance for the duration of the working relationship.
  • Create measurable outcomes and work on performance management goals.
  • Ensure you have a good pricing structure that also includes incentives for best pricing and service trade-off.
  • Have a relationship management structure that helps foster collaborative working relationships.
  • Make sure there is an exit management element included, because even the best plans don't always work out like you expect.

Differences Between Outsourcing and Contracts

A general contract is a binding agreement that can be enforced under the law and is made regarding a specific action. An outsourcing agreement is an arrangement where a company outsources some of its business tasks to another company and utilizes a contract to decide on what will be outsourced.  

Benefits and Drawbacks of Outsourcing Agreements

Benefits:

  • Cost Savings: Reduces overhead by eliminating the need for in-house staff and infrastructure.
  • Access to Expertise: Leverages specialized skills and technology.
  • Scalability: Allows quick expansion or reduction of services based on demand.
  • Focus on Core Business: Frees internal resources for strategic priorities.

Drawbacks:

  • Loss of Control: Less direct oversight of operations and processes.
  • Confidentiality Risks: Increased exposure of sensitive business information.
  • Dependency on Provider: Business continuity may be impacted if the provider fails to deliver.
  • Hidden Costs: Changes in scope or delays can increase expenses.

Balancing these factors is essential when deciding whether to outsource and in structuring the agreement accordingly.

What to Include in Your Outsourcing Agreement

It's recommended to start with something that includes basic identifying information like the agreement and effective dates as well as the names of contract parties and their addresses. There is a variety of other sections a good outsourcing agreement should include:

  • Detailed description of services
  • Deliverables
  • Payment schedule, often a net-30 basis
  • Terms and conditions
  • Insurance requirements
  • Warranties
  • Inspection and acceptance
  • Governing law
  • Independent contractor clause
  • Force majeure
  • Severability

The agreement should discuss retained rights and the fact that each party retains all rights, interest, and title to its own pre-existing intellectual property. The provider should not use pre-existing intellectual property unless it has the right. If the provider lacks sufficient rights, they will need to obtain them from the rightful owner as required in order to perform the services outlined in the agreement. The service provider should offer the warranty that deliverables and services are original and do not infringe on anyone else's intellectual property.

The clause on confidentiality should be detailed and discuss what constitutes confidential information and how sensitive information is to be handled. It should include specific details on customers' confidential information and what is not to be disclosed to third parties, such as the following: 

  • Deliverables
  • Ideas/concepts
  • Designs, drawings, models
  • Research and development
  • Marketing plans
  • Pricing lists, policies, and other financial information

If there is a right to cancel, the section should include the terms that allow for the agreement's termination: 

  • Is there liability for canceling?
  • Is written notice needed, and how many days' notice is required?
  • What are the non-performance penalties?
  • How many days does provider have to correct for breach or failure to perform?
  • How will information and documentation be handled upon termination?

Frequently Asked Questions

1. What is the main purpose of an outsourcing agreement?

It sets out the terms under which a service provider will perform specific tasks or services for a company, ensuring clarity on responsibilities, deliverables, and compensation.

2. How does an outsourcing agreement differ from a general contract?

While both are legally binding, an outsourcing agreement specifically transfers certain business functions to an external provider under defined terms.

3. What are the most common types of outsourcing agreements?

Project-based, dedicated team, time-and-materials, managed services, and build-operate-transfer agreements.

4. What clauses are most important in an outsourcing agreement?

Service descriptions, performance metrics, payment terms, intellectual property rights, confidentiality, termination, and dispute resolution provisions.

5. How can risks in outsourcing be reduced?

By including clear performance standards, robust data protection measures, contingency plans, and exit strategies in the agreement.

If you need help with an outsourcing agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.