IT Outsourcing Contracts | A Simple Guide To Complex Legal Matters

IT Outsourcing Contracts | A Simple Guide To Complex Legal Matters

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IT Outsourcing Contracts | A Simple Guide To Complex Legal Matters

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Outsourcing comes with great advantages for your company, but can also have a lot of complications when it comes to dealing with and maintaining legal contracts.

We have prepared a thorough guide for anybody considering outsourcing. Did you realize that not having a fail-safe outsourcing contract might cost your business a lot of money? Read the guide to learn everything there is to know about the legal and technical aspects of an outsourcing contract.

What you will learn from this article:

  • What are the key advantages of outsourcing for businesses?
  • What should a well-defined outsourcing contract include?
  • How do time and material outsourcing contracts work, and when are they suitable?
  • What are the pros and cons of fixed-price outsourcing contracts?
  • When should a company consider a dedicated team outsourcing contract?
  • What is the importance of intellectual property protection in outsourcing contracts?
  • How can businesses safeguard their intellectual property when outsourcing to other countries?
  • What clauses should businesses avoid including in their outsourcing contracts to prevent potential issues?

What is Outsourcing?

Outsourcing is a known business practice in which companies hire third-party company to provide services or job functions.

Outsourcing can be highly beneficial in many situations and provides great advantages such as:

  • Lower prices (due to economies of scale or lower labor rates)
  • Increased productivity
  • Increased attention on strategic planning skills due to variable capacity
  • Access to resources or skills
  • Increased adaptability to shifting business and economic circumstances
  • Accelerated time to market
  • Lower ongoing investment in internal infrastructure
  • Intellectual property, creativity, and thought leadership are all accessible.
  • Possible financial infusion as a result of the asset transfer to the new supplier

What Is an Outsourcing Contract?

outsourcing contracts and fixed price contract

In their most basic form:

Outsourcing contracts are legal papers that describe exactly what you anticipate from the outsourcing business.

It's a contract that both the parties of an outsourcing project sign. It provides data and specifics on the quality attributes, timeframes, price, incentives, and other aspects of the outsourcing agreement that the two parties are entering into, in addition to the job requirements. The contract also covers legal concerns such as intellectual property rights, non-disclosure provisions, and more.

Types of Outsourcing Contracts

Let's get to know the different types of outsourcing contracts:

Time & Material Outsourcing Contract

This methodology is used when a long-term software development project requires an assessment of time or expenses that cannot be prepared in advance. This sort of outsourcing contract is based on the IT services or products requested and the time it takes to accomplish them.

This is a common form of an outsourcing contract that increases versatility and streamlines the completion of long-term projects. Only when the client's criteria are met as the final delivery, does time and the material contract end.

When to Consider Going with a Time & Material Outsourcing Contract?

  • When the project's main demand is flexibility
  • When defining the project's scope is impossible owing to its complicated and undeveloped idea
  • When the execution of your project necessitates the use of new technologies
  • When the concept is too unique to predict in advance
  • When you still want to have control over your project while an outside team is working on it

Pros & Cons of Time and Material Contracts

  • Pros - It is a highly innovative and advanced type of Outsourcing
  • Pros - Highly appreciated for an emerging high-tech product
  • Cons - It can be quite complex and raw in terms of cost and services
  • Cons - It requires complete control over the project

Pros & Cons of time and materials contract

Fixed Price/Managed Project Outsourcing Contracts

In a fixed price model your criteria and anticipated expenses are explicitly stated in the RFP. As the name implies, it has a set price that must be paid for a certain service. The fixed-cost outsourcing contract limits your options and participation in the project scope. This is one of the most frequent forms of outsourcing contracts, and it's mostly used for IT outsourcing.

When should you consider going in a Fixed Price Outsourcing Contract?

  • When you know precisely what you need and can communicate it to the outsourcing firm
  • When the project work must be completed in a shorter amount of time
  • When you know the job will be easy and won't require many adjustments once it's finished
  • When you choose the managed project strategy, you don't have to worry about handing over control to the firm.

Pros & Cons of Fixed Price Outsourcing Contracts

  • Pros - It gives you power over the budget and control cost
  • Cons - Only good for very small term projects or services
  • Cons - Not ideal for a dynamic development process flow especially at the MVP build stage
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Dedicated Team Outsourcing Contract

You can engage a dedicated crew to work on nothing but your web development job in this approach.

You are employing a team to work on your development projects, and the outsourcing contract will spell out any clear objectives or parameters in advance. The group would function as an extension of your in-house team and may be assigned to any project. To create and interact with the team, you can use a variety of engagement models. This will ensure that communication is seamless and unambiguous.

When to Consider to Form a Dedicated Team Outsourcing Contract?

  • When your project is complicated and requires frequent iterations and changes
  • When you're looking to form a long-term partnership with a development team
  • When you need to keep tabs on your offshore workers and the projects, they're working on,
  • When you're ready to expand and require a dedicated team of developers to work on your project

Pros & Cons of Dedicated Team Contracts

  • Pros - Good for a long term project and collaboration
  • Pros - Helps in business expansion by dividing the workload into skilled labor
  • Cons - Complete control over the project and constant monitoring is required

Why does a Business need an Outsourcing Contract?

Outsourcing contracts protect both entrepreneurs and call centers from any adverse scenarios that may emerge throughout a collaboration. Simultaneously, it acts as a formal document outlining what both sides may anticipate from a continuing agreement. In other words, it governs the whole professional relationship between two companies that both profit from outsourcing. However, drafting one is a time-consuming task.

It aids in the definition of the scope of work and ensures that both parties are legally protected.

What are the Main Components of a Good Outsourcing Contract?

Components of a good outsourcing contract

You must also include numerous outsourcing contract terms and conditions in the outsourcing contract. The following are the major elements of an outsourcing contract:

Detailed Project Scope

The first component of an outsourcing agreement is defined project scope. It explains what service needs your organization has. You can also include the RFP in this part of the contract, including the software outsourcing firm's response during the bidding process. However, ensure that the project's and services' completed scopes are stated properly for the offshore employees to comprehend. This will detail the key services that the outsourcing firm will provide to the customer.

Service Level Agreements (Benchmarks)

The components utilized to acquire a service guarantee from the outsourcing business are SLAs or Service Level Agreements. They establish a standard for the level of service that the firm will provide. They assist in encouraging offshore engineers and achieving your company's objectives.

You can state the expected level of performance and incorporate contractual clauses that penalize the firm if it fails to reach the service level. It is recommended that SLAs be as broad as feasible. To assess performance, include essential service levels, key service levels, and other indicators.

Transfer of Assets

When negotiating an outsourcing agreement, several IT assets must be transferred. Examples of such assets are: telecommunications equipment, computer hardware, equipment leases, and software licensing. To legally transfer these assets to the outsourcing business, a formal sales agreement is necessary.

Warranty For The Product/Project

Outsourcing development to overseas firms comes with several uncertainties and concerns. The outsourcing vendor may even break the contract, resulting in lawsuits that would not only cost a lot of money but would also take up a lot of your or your company's time and effort. It's always a good idea to plan for the worse. It is also necessary to specify in the contract how any such damages would be recovered.

Ownership or Governance Of Product

Every business would like total control over the property rights and the finished output. However, in certain outsourcing arrangements, the vendor and the firm outsourcing IT services may share ownership of the software developed.

It may occur when an outsourcing firm customizes its current software or presents a customer with an expansion of its existing software. Whether you're getting new software developed or application modernization, the firm should explicitly state the software's legal title in the outsourcing contract to avoid any future conflicts.

IP Protection Clause

IP protection clause in business process outsourcing

The biggest concern for clients is that their intellectual property, such as their ideas, would be pirated if they share them with an outsourcing firm. It is necessary to include terms to safeguard your intellectual property when outsourcing software development to such countries as India, China.

Here are some other tips to protect your IP legally:

  • Copyright of your intellectual property
  • Trademark for software or other goods
  • The trade secret of the information
  • Patent protection & application

IP Risks in Software Development

After you've grasped the nature of the IP risks associated with software development, we'll go through six ways to safeguard your IP.

  • Before signing a contract with a vendor, it is critical to do thorough research on the vendor.
  • Sign a non-disclosure agreement (NDA) with a vendor before employing them or after hiring them (but definitely before disclosing any private information with them).
  • Remember that from country to country, the legal framework and accessible mechanisms to safeguard intellectual property rights vary.
  • A Master Service Agreement is a contract that spells out the conditions of any future contracts between the parties.
  • Make sure you're working with a company that follows proper processes.
  • When outsourcing to external parties, restricting server and data access is another way to safeguard your intellectual property.

Cost & Payment Structure

This is particularly useful when the outsourcing model is a fixed-cost model. In reality, each outsourcing contract should explicitly state the outsourced arrangement's cost, payment method, and payment structure. It should provide answers to the questions of when, how, and who to charge. Aside from that, the amount to be paid and how it will be broken up should be clearly stated.

Dispute Resolution Section

When you outsource your job to a team outside of your organization, the likelihood of a disagreement increases dramatically. And, to avoid legal conflicts, you must be prepared for such disagreements. To address such disagreements, a third party or arbitrator should be appointed, and his or her presence should be noted in the outsourcing contract.

Duration For Completion

In many situations, such as the fixed-cost model, the  project scope is obvious, and setting a timetable is not problematic. It is critical to specify the term for which the deal will be in effect in the contract. The length of your contract has a significant impact on whether your outsourced project succeeds or fails.

Subcontracting Clause

Another common issue from outsourcing purchasers is whether the software outsourcing firm itself will supply the services or be subcontracted to other developers. While many outsourcing firms desire this freedom in their outsourcing contracts, the decision to allow or prohibit subcontracting is entirely up to you.

Indemnification Clause

Outsourcing contracts may at times raise some legal concerns. An indemnity provision guarantees that any outsourcing business negligence is borne solely by the service provider. This safeguards your business against any losses that may occur during or after the project.

Exit Strategy

How do you end the outsourcing contract? Would it be detrimental to your business? Will you be able to control the software completely? All of this should be addressed in your outsourcing contract's exit strategy section. The software development firms you select should be willing to work with you on your exit strategy.

Top legal aspects to focus in an outsourcing contract

  • Retained Rights: This describes each firm's pre-existing intellectual property and stipulates that those parties retain all rights to their previously developed intellectual property.
  • Pre-existing Intellectual Property: This section builds on the first by discussing what pre-existing intellectual property is, how to utilize it, what it can't be used for, and so on.
  • Ownership of Deliverables: Who owns the deliverables once they've been completed?
  • No Rights to Customer Intellectual Property: Essentially, this means that the third party will not keep any intellectual property from their clients, even if the client agrees to let them use it to finish their contract.
  • Confidential Information: This section explains what "confidential information" is, how to utilize it, secure it, and other related topics. This section might include a colossal amount of legalese. Following that, most contracts transition to 'customer private information,' which protects the contractor and the contractee.
  • Non-Disclosure: This refers to how information is disseminated to the public and similar matters. More information about this sort of paper may be found here. Information about the right to disclose is usually included as well.
  • Disclosure of Potential Conflicts of Interest
  • Termination and How It Works: This part is fairly lengthy, and it covers who has the authority to terminate the contract, when, how, and under what conditions. Then it goes on to explain what happens if the contract is terminated.
  • Ensuring Provider Compliance: The final section requires the provider to agree that they will not infringe on patents or other intellectual property laws, that they will finish the duties in a professional direction, that they will do the quality work, that they have all of the authorizations they require, and that they will follow all applicable laws.
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Clauses to Avoid in an Outsourcing Contract

There are some key clauses that we recommend you avoid in your contract as they might bring more bad than good to you and your business. Here’s a list of the ones that should make your red light go on.

1. Terms of the contract stating that the buyer is responsible for all exit management fees.

2. Contract terms that say your supplier's advice and statements aren't included.

3. Contract terms that include KPIs that aren't related to the project's goals

4. Contract clauses that restrict a client's ability to correct a fault

5. Contract terms that don't specify for how long service can be suspended.

6. Contract Terms that eliminate client expenses if results aren't reached

7. Contract Terms that denote service credits as THE remedy for poor performance

8. 'Agree to Agree' Contract Terms

9. Contract clauses that exclude you from paying any costs if something goes wrong.

10. For extra project work, standard contract terms apply.

11. Contract terms with no agreed-upon cooperation

12. Contract terms that shift risk on testing and acceptance

13. Contract Terms that assume all changes are chargeable


To conclude the article, we recommend first negotiating the parts of the contract with the third party because once the contract is formed, you will need to be obliged to it at all cost. At your end, create a skeleton contract first and leave the rest for negotiations. Once you are done negotiating, and the terms are finalized, you can form the final draft of your outsourcing contract. In some cases, the software house can provide you with a ready-made contract template based on their previous agreements. It will give you a head start and simplify the negotiation process.

Another important thing to consider while forming an IT outsourcing contract for your business is to make sure you include complete and straightforward details to avoid confusion and misunderstanding. The agreement should be crystal clear. A well-defined outsourcing contract can be the key to a profitable outsourcing venture.

If you are looking for an IT outsourcing company for long or short-terms of projects, then don't forget to contact us. We will provide you not only with the best talent in the town with exceptional services, but we will also keep everything crystal clear in creating a well-drafted outsourcing contract. Contact us Now!

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