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Outsourcing grows in complexity

|Written By Daryl-Lynn Carlson
Outsourcing grows in complexity

The practice of outsourcing a portion of a company’s operations was once perceived as a practical means of realizing cost savings or securing access to a much-needed labour pool. But the complexities of such arrangements are growing as more deals go sour.

Therefore, the sheer detail that needs to be considered in the preparation of contracts and covenants to protect corporate interests means corporate counsel will likely need help.


Whether the outsourcing service provider is domestic or overseas, the due diligence involved will extend beyond the purview of in-house counsel capabilities.


“You can be the best in-house counsel but there’s no way you can have the breadth of knowledge to manage all these issues for your company,” says Theo Ling, a partner at Baker & McKenzie LLP in Toronto whose practice involves advising companies and corporate counsel on outsourcing, commercial agreements, and compliance issues.


The biggest challenge, he says, is that the scope of issues that need to be taken into consideration is well beyond just legal concerns. “I know as part of the compliance requirements their job is increasingly managing not just legal risks but all these other types of risks,” says Ling. “They really need to see the big picture.”
Lisa Abe, partner at Fasken Martineau DuMoulin LLP, focuses on facilitating offshore outsourcing and agrees the magnitude of issues to be considered has broadened.


“I think that right now, given what we’ve seen in the news recently, the big concerns with international outsourcing from a social-responsibility perspective are things like child labour, money laundering, terrorism, animal rights, breaches of privacy, or even pollution,” she points out. “It’s the company’s reputation that’s at stake.”


She agrees outsourcing is by no means a surefire means to reduce expenses.


“If you’re looking at outsourcing to save costs, there are all kinds of hidden costs that pop up,” Abe says. She says one of her clients is trying to wind down its deal with an outsourcer in China after a major breach in privacy that resulted in lost trade secrets and the theft of intellectual property.


“So it’s not just the cost of getting the service cheap. What’s the cost of losing trade secrets or the intellectual property, and what’s the cost of bringing the operation back?”


For her corporate clients, Abe provides a detailed inventory of issues and challenges that a company needs to know well in advance of drafting a contract. They range from the preparation of economic forecasts in developing countries and knowing the application of local laws to understanding differences in culture, business, political, and legal climates that can have implications on how contracts and covenants are negotiated.


In a paper entitled “International outsourcings give rise to unique legal and business challenges,” she notes that a typical international outsource often has affiliates and subcontractors in multiple jurisdictions that also must be subjected to the client’s contractual requirements.

 
“To address this, the parties have to create a deal structure that ensures the rights and obligations of all parties involved in the outsourcing are adequately protected and liability risks are appropriately limited,” she writes. “Privity of contract and enforceability become a key issue.”


In deals that involve the movement of resources, data, and personnel across borders, “one cannot escape the application of local laws to issues such as contract enforcement, transfer of money, tax, insolvency, creditors’ rights, employment, real estate, regulated industries, privacy, data protection, and intellectual property,” she notes.


In fact, in the event a service provider becomes insolvent, Canada’s insolvency and bankruptcy laws are not enforceable, although Abe says still, “We see it all the time; it’s boilerplate in every contract. But under Canadian insolvency law, those ipso facto clauses can be overridden by a court in an insolvency or bankruptcy.”


As well, she says, service providers abroad sometimes underprice their fees in order to secure a contract, so it’s important to include provisions to monitor performance indicators and obtain credit references.


Most outsourcing contracts also contain early termination clauses, although “what we’re seeing now is an expansion of the events of termination,” says Abe. “While it would typically be termination for breach of service, the termination events are broader, such as violations of security or privacy, personnel or type of processes they have, whether they’re environmentally friendly,” she explains.


“They even may be immediate causes, as opposed to the usual standard of ‘if there’s a breach there’s a cure’ period. Some of these breaches are quite serious and can’t be cured, and if it’s going to affect your reputation of your company, you want out of that contract as quickly as possible,” she says. “So transitioning out as part of the termination is something corporate counsel has to look at carefully.”


Ling at Baker & McKenzie affirms termination clauses are getting more focus.


“What I think is interesting is now that outsourcing is sort of in the mainstream is with a lot of companies that have had some experience, a lot of those experiences aren’t great, the expectations when they go in are not necessarily met,” says Ling. “So what they’re trying to do is renegotiate the outsourcing agreement after a period of time or to get out of it and get into a new one. There’s a lot of focus and attention around that now.”


He points out that rescinding agreements and switching providers presents another cache of issues that have been emerging. “Before, you were lucky to get privacy clauses in an agreement that would articulate the responsibilities of each party relating to personal information,” he says. “Now people are trying to think beyond that. The privacy and corporate compliance issues are increasingly higher profile issues on any of these outsourcing transactions.”


There are cost-of-living index issues, currency fluctuations, inflationary projections that need to be taken into consideration in the jurisdiction of the outsource provider that also add to the risks, he says. “So, as corporate counsel, you’re trying to figure out what is the currency fluctuation or cost of living index for India and saying, ‘What do I know about that?’ That tends to be a real challenge because you won’t be able to figure that stuff out yourself and you can’t rely on the outsourcer because they have a different vested interest,” he says.


Details — right down to the workplace environment, employee-retention strategies, and dialogue between the two locations  — need to be agreed upon contractually to be effective, says Ling. “Most people in the outsourcing world would say the nature of outsourcing is it’s an organic beast. It’s not static; it’s a relationship,” he emphasizes. “But a lot of the deals that have been put together don’t allow for that.”


And when it goes off the rails, it is inevitably shovelled onto the lap of the corporate counsel department to resolve, he adds. “They’re the ones getting called in and being told the contract is not working.”


Anthony (Tony) Morris, a partner at Macleod Dixon LLP in Calgary, concurs it’s the in-house lawyer(s) who will bear the brunt of winding down a bad deal. “Corporate counsel oftentimes gets side-swiped with the responsibility for the fallout of contracts that are not managed very well, and they end up having to jump in and take responsibility in a way that is a real challenge,” he acknowledges. “And it is somewhat unfair.”


Morris, whose practice is focused on technology-related corporate and commercial transactions, says his outsourcing clients tend to procure services in North America rather than overseas. Still the concerns are the same.


“Outsourcing is really different from other service agreements,” he says.


 “You have to think ‘convey’ and ‘re-convey.’ These are contract deals that need a heavy dose of managing and fine-tuning, either during the course of the transaction or during the course of the service delivery. At the front end of the agreement, the company may be looking for cost-saving or functionality improvements,” although “you’ve always got to think about how to unwind that deal. Corporate counsel needs to understand the implications to the business in the long term.”


He says it’s particularly important that corporate counsel ensure all levels of management who will be involved in overseeing the outsourced services are designated their duties long before the RFP even goes out. “A lot of times the executives don’t do that. They get the contract done and start from there.” Those involved as direct project managers should know the contract and its interpretation inside and out, he says.


Often the insights Morris provides to ensure a deal works go well beyond legal issues.


“I think the most valuable thing that I try to do when I engage with in-house counsel who’ve had a bit more experience in outsourcing is how to make the deals work in the longer term,” he says. “Sometimes that’s not much in the way of legal advice at all.”


It goes back to big-picture forecasting and looking at the operation as a whole to weigh variables that can impact any single aspect of business, he says.


That’s why outside advice is most valuable, as at the end of the day “corporate counsel ends up living the consequences after the contract is signed,” he highlights. “If they are involved in the deal then they are the folks who live the actualization of the contract, good or bad.”


Cathy Samuel, a partner at McCarthy Tétrault LLP in Calgary, represents outsourcing service providers. She acknowledges her clients are, for the most part, sophisticated service providers based in North America, contracted by utility companies, customer service clients, workplace benefits, or government procurement. She says that almost all corporate counsel she works with on deals come to the table with law firm representation.


“There are some who are really savvy but they still have their lawyer there,” she says, referring to the growing complexities involved in outsourcing even just within the continent. “So, yes, customers will always have counsel. I’ve never seen them without it.”

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