Legal Issues Arising in IT Outsourcing

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					Legal Issues Arising in
IT Outsourcing

George A. Wowk
       Outline of Presentation
• Introduction
• Outsourcing generally
• Information technology infrastructure
  – general considerations
  – legal issues
     Intellectual Property Practice
•   Patents
•   Copyright
•   Trademarks
•   Trade secrets
•   Confidential business information
•   Domain names
          Technology Practice
•   Software
•   Computer services
•   Internet
•   Biotechnology
•   Purchases and sales
•   Commercialization
•   Privacy
• Business process outsourcing
• Information technology outsourcing
• Definition
  – turning over a critical technology function or
    business operation
  – to a third party service provider
• Service description
• Risk allocation
  Business Process Outsourcing
• Customer relationship chain
   – call centre
• Supply chain
   – automotive parts manufacturing
• Organizational productivity chain
   – product assembly
   – service delivery
• Product and service innovation chain
   – engineering services
      Information Technology
• ASP arrangement
• IT services
• IT infrastructure
          ASP Arrangement
• Third party hosts software application
  and data
• Usually over the internet
• Not a software license
• Many similar issues arise
        Information Technology
•   Highly complex arrangement
•   Significant number of legal issues
•   Third party takes over a critical function
•   Many interfaces with critical functions
•   Relationships can last 10 years or longer
•   Buyer's needs, technology and services will
    likely change significantly
        Recent Transactions
• HP and British Telecom
• IBM and Lloyds TSB
• HP and Proctor & Gamble
       HP and British Telecom
• BT to take over HP’s voice and data
  networks and product support call centres
• HP take over BTs IT infrastructure
• 330 employees transferred between the
• Team up to provide outsourcing services to
   – US$1.5 Billion in revenue expected
• 7 years
          IBM and Lloyds TSB
•   In talks
•   US$1.8 Billion
•   10,000 employees affected
•   10 years
•   Computer systems and network
•   ABS machines
•   Online baking systems
•   Branch computers
     HP and Proctor & Gamble
• US$3 Billion
• 10 years
• Management of IT infrastructure, data
  centre operations, desktop and end-user
  support, network management, some
  application development
• HP to take on 1,850 employees
• Chunnel
  – US$21 Billion
  – 31 mile rail
  – 6 years
• Big Dig, Boston
  – US$7.7 Billion
  – one of most technically challenging infrastructure
    projects ever in the US
  – 13 years
           Reasons to Outsource
• Organizations concentrate on
    – core competencies
    – key differentiators
•   Cost savings
•   Additional capital if assets sold
•   Access to better technology and expertise
•   Better service
•   Greater flexibility in scaling up and down
•   On-demand pricing
    Ann Livermore, Executive Vice
    President, Technology Solutions
              Group at HP
Some customers will say that they believe
they cannot keep up with the change and
all the technologies and knowledge they
need to manage the environments. I guess
that is similar to saying it is too complex
and they want to have someone who is
more of an expert and has the critical mass
and the scale advantages to take it over
and manage it for them.
                 Buyer's Risks
•   Savings not realized
•   Poor service/unhappy users
•   Changing circumstance of buyer
•   Service provider exits/bankruptcy
•   Switching service providers at end of
•   Difficulty in implementing changes
•   Technology platform lags
•   Loss of control
•   Loss of skill
      Service Provider's Risks
• Unanticipated costs
• Nightmare buyer
• Large upfront investment
  – purchase of assets
  – putting infrastructure in place to provide the
  – Return on investment
                Mutual Risks
•   Unclear contractual terms
•   Unanticipated requirements
•   Change management
•   Parties goals are in conflict
•   Relationship deteriorates
•   Cooperative/win-win
•   Share the benefits/cost savings
•   Flexibility
•   Senior management buy-in
           Use an RFP Process
•   Include important business requirements
•   Include important legal provisions
•   Helps with the exchange of information
•   Moves negotiations along
•   Encourages competitive bids
•   Attracts additional ideas
•   Get ballpark on pricing
                  Due Diligence
• Review agreements that are being transferred
   –   software
   –   services
   –   hardware
   –   facility
• Nature and state of assets being transferred
• Financial strength of service provider
• Service capability of service provider
     Management and Control
• Buyer to retain control over strategic
• Ability to implement changes in services
• Outsourcing the "how", not the "what" or
            Pricing of Services
• Purchase of operations
• Base fee
• Unit fee based on use
   – CPU
   – transactions
   – bandwidth
• Incentives based on exceeding objectives
• Part of any cost savings passed on to buyer
• Pass through of third party expenses
   Pricing of Development and
     Supplementary Services
• Services outside outsourcing
  – requires well defined service description
• Time and materials
• Captive audience – may not get
  competitive rates
• Allow third parties to bid
• Potential for conflict on procurement
  – whose hardware will HP recommend?
             Focus on Price
• Grind the service provider leads to
  animosity/unhappy relationship
• Parties creating value through the
  – share benefit
• Inland Revenue
          Service Description
• Needs to be detailed
  – "run network"
  – all rights and obligations will flow from
  – what is included and what will be at an
    additional cost?
• At the same time need flexibility
• Transition services
          Operational Services
•   Network management
•   Hardware
•   Software
•   Help desk
•   Ecommerce/website
•   Telecommunication
•   Backup
•   Disaster recovery
        Ongoing Operational
• Keep software licenses up to date
• Keep maintenance agreements current
• Responsibility for costs
              Service Levels
• Level of performance/quality of service
• Set standards
  – Based on buyer's historical service levels
  – Based on industry standards
  – Negotiated standard
• Need tools to perform measurement
• Conduct audits
    Performance Measures/Service
         Level Specification
•   System availability
•   Application response time
•   Service call response time
•   User satisfaction
•   Error rates
•   System capacity
               Possible Changes
• New technology
    – incentive/requirement to adopt cost effective
•   Changes required by law
•   Business requirements may change
•   Business reorganization
•   Changes to the costs of providing the services
•   Industry standards of performance change
          Adjusting to Change
•   Short term contract
•   Formal change control procedure
•   Service adjustments
•   Benchmarking
•   Renegotiation of terms
• Long term contract
• Benchmark against industry standards for
   – are they truly comparable?
• Adjustments
   – service levels
   – price
• Who is responsible for the cost of
• How often?
   Management of Relationship
• Communication is crucial
  – required meetings
  – primary contacts
• Feedback mechanism
• Internal escalation of disputes to
• Mediation and Arbitration
         Employee Transfer
• Would the service provider be an
  attractive employer for employee?
• Which employees remain with buyer?
• Notification of employees
• Sharing of employee information
  – privacy laws
• Steps taken to retain key employees
• Relocation expense of employees
             Employee Issues
•   Severance costs
•   Job responsibility changes
•   Salary/benefit changes
•   Accrued pension credits
•   Seniority
• General responsibilities and timing
• Who is responsible for service level
  commitments during transition period?
• Transfer of facilities, assets, data, software,
  hardware and employees
• Transfer of maintenance/support contracts
• Transfer of third party licenses and leased
   – consents and additional fees payable
•   Sensitive business information
•   Technical secrets
•   Publicity of arrangement
•   Does service provider provide services
    to a competitor?
             Intellectual Property
• Transfer of ownership of intellectual property
• Ownership of enhancements
   – what if service provider acts for competitor?
   – obligations to apply for patent protection and copyright
• Alternatives
   – joint ownership
   – other party having broad rights under license
       • right to source code, modify and copy
• Ownership/rights on termination
   – critical issue
• Breach of third party rights
• Obligations needs to be defined clearly
• Account for transition phases
• Cure period
              Types of Defaults
• Failure to pay
• Failure to perform
• Service level breach
  – minor
  – serious
• Change of control
• Insolvency
        Right of Termination
• Termination for convenience
• Termination for cause
  – strong incentive for service provider to
• Force majeure
• Insolvency
• Change of control
    Gateway Terminated its IT
     Outsourcing Agreement
• US$400 million seven year contract
  signed Sept 2003
• Terminated May 2004
• Gateway close 400 retail stores and
  layoff 2500 employees
• Large termination fee
•   Full or partial termination
•   Service Credits
•   Refunds
•   Re-performance of services
•   Predetermined estimate of damages
•   Dispute resolution
•   Problem identification/rectification
            Termination Issues
• Payments on termination
   – unamortized costs of the service provider
   – anticipated profit
   – damages
• Transition services
• Repatriation of data, assets, software and
• Assignment of third party agreements
• Non-solicitation of service provider's
• Cost for transfers
         Potential for Liability
• Service provider liable for breaches?
   – mission critical system down for 4 business
   – critical data lost
• Liability to third parties
   – breach proprietary rights
   – loss or damage to property
• Allocation of risk between the parties
        Limitation of Liability
• Liability cap
• Exclusion on certain types of liability
  – loss of data
  – loss of profits
  – consequential and indirect damages
 Service Provider Goes Out of
• Must be able to transition
• Get access to
  –   hardware
  –   software
  –   data
  –   employees
                  Other Issues
•   Insurance
•   Tax
•   Security
•   Privacy
•   Indemnities

George A. Wowk
(403) 260-0130