What are the most common contract forms for outsourcing arrangements, and what are the advantages and disadvantages of each?
The usual structure for outsourcing arrangements comprises an asset transfer agreement and a service agreement. The asset transfer agreement will also contain clauses on the transfer of employees. Sometimes a separate employee transfer agreement is executed to ensure the transfer of employees (‘TUPE over’) to the supplier. It is possible to include everything in one agreement, but that is hardly ever done.
There are many cross-border outsourcing deals. This Is because the Netherlands are the headquarters of a large number of global companies. The cross-border deals are often in the form of a master service agreement and local-to-local local service agreements, all governed by Dutch law.
The Dutch outsourcing association Sourcing Nederland has developed a standard form agreement, which is available in Dutch and in English; however, its use is not widespread since the main law firms specialising in outsourcing prefer to use their own forms.
Before entering into an outsourcing contract, what due diligence is advised?
On the client side, due diligence will focus on contractual constraints (contained in the agreements between the customer and third-party suppliers or clients) and the internal service levels achieved by the customer.
On the supplier side, it is a matter of references by other clients and possibly corporate social responsibility (eg, whether there is child labour in offshore countries).
In general, due diligence is limited on both sides.
Duration and renewal
What is the common duration of outsourcing contracts? How does the renewal process commonly play out?
The most common duration of outsourcing contracts is three plus one plus one, or three plus two years. Five years is also often seen.
Renewal is usually only at the discretion of the client, on the same or better terms. Better commercial terms may be pre-agreed, or they may be negotiated at the time of renewal.
What procedures and criteria are commonly used to select suppliers?
The most common criteria for selecting the suppliers are track record, reputation, quality of service, price, quality of the team offered and continuous involvement of the team that sold the deal.
How are the service specifications agreed and monitored, and what service terms and parameters are commonly applied? Can any flexibility be provided for in these terms?
The service specifications are agreed in a schedule to the service agreement (usually this is Schedule 2), which is a detailed document that focuses on the what more than the how. The service levels may be contained in the schedule or in a separate service-level agreement (SLA). For commodity outsourcing projects (eg, IT infrastructure), the standard service descriptions and SLA of the suppliers are often used.
The service agreement will contain change-management wording and a schedule that makes it easy to jointly change the service description.
The services are monitored against the SLA. This is often carried out by the supplier, who will inform the customer. Most customers understand or are advised not to put service levels and service credits on every little detail. Some also recognise that all-green service-level dashboards may not tell the true story because the wrong topics are measured; therefore, the service-level overall customer satisfaction on the work floor level is sometimes used.
Finally, output-based service levels are not uncommon.
What charging methods are commonly used?
Volume-based pricing is very common: the higher the volume, the lower the price per unit. This is also known as additional resource charges and credits – the method developed by TPI three decades ago.
Output-based pricing is also often seen. This means that the supplier is paid or paid more if the pre-agreed goals are met (eg, the number of cars that leave the factory on time will determine the fee of the IT suppliers).
Warranties and indemnities
What warranties and indemnities are commonly stipulated in outsourcing contracts (for both the customer and the supplier)? Are there any mandatory or prohibited provisions in this regard?
The asset transfer agreement only contains title warranties and, where relevant, a warranty that the transfer assets were all the client was using to render the transferred activities itself. The asset transfer agreement will contain indemnities regarding the employees, protecting the supplier against unintended transfers and the client against employees who did not transfer but should have.
The service agreement will contain limited warranties on the quality of the services (provision of the services in accordance with the service description or the specifications, or with good industry practice, reperformance if in breach, etc). Standard third-party IP indemnities are included for custom-built software. It is also quite common that the supplier indemnifies the customer for damages the customer suffers as a result of breaches of data protection legislation attributable to the supplier, though this indemnity is often capped due to the height of potential fines under the GDPR.
Ending the agreement
What are acceptable grounds for terminating an outsourcing contract?
Acceptable grounds for terminating an outsourcing contract are material breach and termination for convenience. The latter is for the customer only. In regulated industries, termination may occur if a supervisory authority demands it.
How do contracts commonly address exit from the outsourcing contract?
The outsourcing agreements usually contain an exit clause and a detailed exit schedule, as well as a draft exit plan. The main topics are smooth transfer, the sharing of information required for the transfer, cooperation, IP rights, ownership or transfer of tools, data and logs, and fees for the transfer.
However, in many cases, the exit wording is not ready on signing, which may result in issues when the exit is forthcoming since the customer will have lost its leverage for negotiating it.
Is there a common or mandatory notice period for non-renewal of a contract?
There is no mandatory notice period for non-renewal of a contract. Common notice periods for non-renewal are 12 to 24 months for the supplier and six to 12 months for the customer.
What can customers do to make their outsourcing contract more successful?
To make their outsourcing more successful, customers should:
- not outsource a mess, but clean it up first;
- focus less on cost savings and more on quality;
- leave sufficient margin for the supplier;
- not overestimate their own service levels;
- engage in frequent governance meetings with the supplier, also at the board level;
- understand the supplier’s business model; and
- focus on output-based service levels and pricing.